## _cr04314

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### Executive summary — background and recent developments
- Growth and the balance of payments have strengthened, driven by high oil prices and increasing investment.
- Macroeconomic tensions:
  - Core inflation has remained in the 10–11 percent range since mid-2002.
  - The ruble is appreciating briskly in real terms; the pace of real appreciation has increased and is now running at nearly 10 percent year-on-year.
  - The ruble has reached 90 percent of the level prevailing before the 1998 crisis in real terms.
- Labor market signals:
  - Real wages have accelerated and are rising faster than labor productivity.
  - Notable labor shortages in Moscow and other high growth regions reflect very limited labor mobility.
  - Strong GDP growth is no longer translating into a decline in unemployment.
- Balance of payments and capital flows:
  - Current account surplus stable at 8–9 percent of GDP for the past two years.
  - Net private capital outflows fell substantially in 2003; banks’ net foreign assets reduced by almost $9 billion in 2003.
  - CBR net international reserves increased by over $40 billion since early 2003; gross international reserves stood at $88 billion in mid-2004.
- Monetary and fiscal interactions:
  - Base money growth accelerated during 2003 and is still running at around 40 percent year-on-year.
  - Policy interest rates have been very low since early 2003.
  - Relaxation of fiscal policy has limited the extent to which higher government deposits at the CBR could sterilize interventions.

### Banking and monetary developments
- Bank credit and money:
  - Bank credits to the economy increased by about 45 percent during the past 12 months, and over 200 percent since the beginning of 2001.
  - Broad money is recovering rapidly, with a notable shift from foreign currency to ruble deposits, and with a reduction in foreign currency holdings outside the banking system.
  - Broad money and bank credits to the economy still amount to only 27 percent and 22 percent of GDP, respectively.
  - Credit surge coincided with booming real estate and, until recently, stock market prices.
- CBR actions and regulatory measures:
  - Reserve accumulation expected to be substantial, at around $20 billion this year.
  - Deposit insurance extended to household deposits up to Ruble 100,000 for all qualified banks; immediate extension to all banks even if not eligible, with any unrecoverable cost to the CBR eventually becoming a charge on the budget.
  - Enforcement that banks not meeting strict prudential eligibility criteria will lose license to take retail deposits by September 2005.
  - Liberalization of capital flows; CBR introduced moderate unremunerated deposit requirements on inflows and outflows effective August 1, 2004.
  - Reserve requirements halved to 3½ percent amid bank runs and liquidity problems.
- Banking system soundness and vulnerabilities:
  - Under Russian Accounting Standards, banks overall profitable and adequately provisioned and capitalized, with improving asset quality.
  - Structural weaknesses: high sensitivity to oil prices; concentrated exposures, many to related parties; non-transparent operating environment; weak creditor rights; inadequate bank bankruptcy law; history of supervisory and prudential forbearance.
  - Recent turmoil: since closure of a bank in May, nine other private banks publicly acknowledged liquidity problems and three have been closed; Guta Bank purchase supported by CBR and state-owned Vneshtorgbank (VTB) after deposit run.

### Fiscal developments, oil-price sensitivity, and budget risks
- Fiscal outcomes and adjustments:
  - General government recorded a surplus of about 1 percent of GDP in 2003 (only ½ percentage point higher than in 2002).
  - Measured at a constant oil price of $20 per barrel, the general government deficit increased by 1 percent of GDP, to about 1¼ percent.
  - Staff analysis: a $1 decline in the oil price would reduce revenues by ⅓ percent of GDP (direct effect).
  - Estimates: a reduction in oil prices of $1 a barrel would reduce GDP in the short term by ¼–½ percent; indirect budget impact of a $1 price change could be nearly ½ percent of GDP. Total impact on the budget—direct plus indirect—of a $1 change in the oil price could be nearly ½ percent of GDP.
- Budget plans and stabilization:
  - 2004 budget envisages planned tightening of almost 1 percent of GDP by reducing non-interest expenditures; would nearly balance the budget at an oil price of $20 per barrel.
  - Creation of an oil stabilization fund: revenues arising from oil prices above $20 per barrel are accumulated in the fund.
  - Draft 2005 budget entails reduced saving of oil revenues and attendant relaxation of fiscal policy.
- Draft 2005 specific pressures:
  - Plans include cutting the unified social tax (UST) and monetizing many in-kind benefits at a cost to the 2005 budget of about 2 percent of GDP.
  - UST cut estimated to reduce revenues of extrabudgetary funds by 1¼ percent of GDP; draft budget envisages increased federal transfer to the pension fund to cover about half of this shortfall.
  - Federal spending to increase by about ¾ percent of GDP to finance monetization of in-kind benefits.
  - Authorities stated only half of revenues above the Ruble 500 billion cap (about 2¾ percent of GDP) would be saved once the cap is reached; cap expected to be reached by mid-2005 under oil price assumption of $26 a barrel.

### Structural reforms and investment-climate agenda
- Authorities intend a broadly-based acceleration of reforms with priorities:
  - General administrative reforms; comprehensive reforms of health, education, housing, and military sectors; tax and banking reforms; ongoing reforms of natural monopolies.
- Investment-climate focus:
  - Reduce dependence on oil by improving the investment climate, beginning with public sector reforms.
  - Housing reforms to develop the mortgage market and improve labor mobility.
  - Banking sector reforms to improve financial intermediation, especially for SMEs.
  - WTO accession to catalyze reforms and promote competition; bilateral negotiations completed with partners accounting for three-quarters of trade but outstanding market-access issues remain.
- Staff appraisal and risks:
  - Staff welcomed reform thrust but concerned about lack of specificity, weak implementation capacity, and political resistance.
  - High oil prices and strong growth may be causing complacency about reforms.
  - Handling of the Yukos case could damage investment climate and confidence if not transparent and even-handed.

### Outlook, projections, and risks
- Growth and reserves projections:
  - Staff projects GDP growth of 7¼ percent in 2004, slowing to 6½ percent in 2005, on assumptions of Urals oil price of $30 a barrel in 2004 and $28½ in 2005.
  - Authorities project 6½ percent growth in 2004 and 6 percent in 2005, based on Urals oil price assumptions of $29 and $26 a barrel respectively.
  - Growth assumed to slow over medium term to about 5 percent (trend).
  - Reserve accumulation around $20 billion in the year; gross international reserves projected to rise over 2004–05 (see tables).
- External and debt outlook:
  - Current account surplus likely to decline as oil and commodity prices return to normal levels.
  - Public external debt, net of reserves, has fallen close to zero; gross public external debt currently around 20 percent of GDP, projected to fall below 10 percent by 2007; total external debt projected to stabilize at just under 30 percent of GDP.
- Downside risks highlighted:
  - Oil price decline.
  - Turmoil in the banking system undermining investment and capital flows.
  - Handling of the Yukos affair potentially impacting investment and capital flow volatility or disrupting oil production.

### Policy discussions and staff recommendations
- Fiscal policy:
  - Staff recommended no further loosening of fiscal policy at this point; fiscal policy should not add stimulus given macro tensions.
  - Additional measures yielding savings or revenues of 1–1¼ percent of GDP in 2005 were needed per staff analysis.
  - Revenues from oil prices above $20 per barrel should continue to be saved in the stabilization fund and the cap on the fund should be lifted.
  - Staff argued subnational governments should be assumed to balance budgets at best; draft budget’s assumed regional spending cuts judged unrealistic.
- Monetary policy:
  - Staff recommended monetary policy should focus on reducing inflation, unburdened of exchange rate objectives; take advantage of disinflationary impact of nominal appreciation.
  - CBR officials insisted on dual targeting (reduce inflation and stem ruble appreciation) and saw fiscal tightening as the appropriate instrument for exchange-rate objectives.
  - Sterilization: CBR officials argued sterilization largely ineffective; mission saw more scope but agreed large-scale sterilization would not be effective.
  - Unremunerated deposit requirements seen by staff as temporary, transitory, and not a substitute for flexible exchange rate policy; they raise cost of capital, especially for SMEs.
  - CBR intends to move to inflation targeting over the medium term; technical requirements likely in place in 2–3 years, at the earliest.
- Banking sector and financial stability:
  - Urgent need to strengthen supervisory and regulatory framework and crisis management tools.
  - Key needs: rapid depositor payouts under deposit insurance; amendments to bank bankruptcy law to allow speedy resolution; broaden eligible collateral to facilitate targeted liquidity; CBR transparency and expeditious action when closing banks.
  - Staff emphasized tackling problems now while systemic vulnerabilities are manageable and recapitalization resources exist.
  - Medium-term priorities: move to risk-based supervision; improve governance and transparency of bank ownership; adopt International Financial Reporting Standards.
  - Concern over lack of a strategy for state-owned banks (notably Sberbank) and overdominance of state banks potentially stifling competition.
- Structural reform guidance:
  - Staff supports strategy to diversify the economy and double GDP in ten years focusing on tax shifts, saving windfall oil revenues, and rationalizing public expenditure.
  - Medium-term structural fiscal reform key points include cutting non-oil tax burden by about 1 percentage point of GDP a year, increasing taxation of oil sector rents in high-price periods, and rationalizing public expenditure and quasi-fiscal activities.

### Key quantitative indicators (as reported in the source)
- GDP growth: rose to 7¼ percent in 2003; first half of 2004 suggests growth around 7½ percent.
- Core inflation: 10–11 percent since mid-2002.
- Real exchange rate appreciation: nearly 10 percent year-on-year.
- Current account surplus: stable at 8–9 percent of GDP for the past two years.
- Change in banks’ net foreign assets: reduction by almost $9 billion in 2003.
- CBR net international reserve accumulation: over $40 billion since early 2003.
- Gross international reserves: $88 billion in mid-2004 (around seven months of imports and more than 200 percent of short-term external debt).
- Base money growth: around 40 percent year-on-year.
- Banking sector headline statistics (selected):
  - Deposits: 21.2
    - Enterprise deposits: 9.5
      - Sberbank, VEB and VTB: 2.0
      - Other banks: 7.6
    - Household deposits: 11.6
      - Sberbank, VEB and VTB: 7.4
      - Other banks: 4.3
  - Banking system assets: 42.2
    - Sberbank, VEB and VTB: 22.5
    - Other banks: 19.7
  - Credit to the economy: 22.4
    - Sberbank, VEB and VTB: 6.5
    - Other banks: 15.8
  - Number of banks: 1,329
    - State-owned: 1/6
    - Foreign-owned: 2/128
    - Other: 1,195

### Macroeconomic projections and selected table highlights
- Staff projections (Table 1 / Table 2 excerpts):
  - Real GDP: 2004: 7.3; 2005: 6.4.
  - Consumer prices (period average): 2004: 10.3; 2005: 8.6.
  - Consumer prices (end of period): 2004: 10.0; 2005: 7.5.
  - General government overall balance (commitment basis): 2004: 3.1; 2005: 1.7.
  - Base money (annual percent change): 2004: 24.0; 2005: 23.6.
  - Ruble broad money (annual percent change): 2004: 35.3; 2005: 18.3.
  - Total exports, fob (billions of U.S. dollars): 2004: 174.0; 2005: 181.0.
  - Total imports, fob (billions of U.S. dollars): 2004: -95.5; 2005: -113.7.
  - External current account (in billions of U.S. dollars): 2004: 46.8; 2005: 31.5.
  - Gross international reserves (in billions of U.S. dollars): 2004: 97.0; 2005: 115.5.
  - Real effective exchange rate (average percent change): 2004: 9.3; 2005: 11.5.

### Public debt stress test — "One time 30 percent nominal depreciation in 2004" (scenario 6)
- Scenario label: "One time 30 percent nominal depreciation in 2004".
- Footnote: Real depreciation defined as nominal depreciation minus domestic inflation (based on GDP deflator).
- Projected impact on public sector debt ratio series (scenario 6): 34.3; 29.5; 26.5; 24.5; 22.6; 21.4.
- Comparative context within stress tests (selected outcomes):
  - Baseline (historical averages): 27.8; 28.2; 28.3; 28.4; 28.1; 28.2.
  - Primary balance shock (historical average minus two standard deviations): 34.4; 42.7; 39.0; 36.6; 34.3; 32.9.
  - Oil price shock scenario (fall to $15 in 2005–06 and $20 afterwards): 20.1; 34.2; 37.0; 37.4; 37.6; 38.5.

### Executive Board and Directors' key messages
- Directors commended macroeconomic management that strengthened GDP growth and the balance of payments.
- With a buoyant economy, Directors advised:
  - No fiscal stimulus at this point in the economic cycle.
  - Monetary policy should focus more on controlling inflation than on resisting nominal appreciation.
  - Central bank should clarify competing objectives of controlling inflation and managing the exchange rate; allow more nominal exchange rate flexibility.
  - Strengthen central bank independence.
  - Unremunerated deposit requirements should be temporary and reserved for exceptionally large and volatile inflows.
  - Strengthen prudential supervision, crisis management, and continue closing unsound banks.
  - Accelerate structural reforms to diversify the economy and improve the investment climate.

*Source: _cr04314 — IMF staff report and supplemental material (Executive Summary, sectoral analysis, projections, and staff recommendations).*

### Executive Summary.......................................................................................................

### _cr04314 - Executive Summary

### Background and recent developments
- Growth and the balance of payments have strengthened, driven by high oil prices and increasing investment.
- Macroeconomic tensions are rising:
  - Core inflation has become entrenched; core inflation has remained in the 10–11 percent range since mid-2002.
  - The ruble is appreciating briskly in real terms; the pace of real appreciation has increased and is now running at nearly 10 percent year-on-year.
  - The ruble has reached 90 percent of the level prevailing before the 1998 crisis in real terms.
- Labor markets are tightening:
  - Real wages have accelerated and are rising faster than labor productivity.
  - There are notable labor shortages in Moscow and other high growth regions, reflecting very limited labor mobility.
  - Strong GDP growth is no longer translating into a decline in unemployment.
- Balance of payments and capital flows:
  - The current account surplus has been stable at 8–9 percent of GDP for the past two years.
  - Net private capital outflows fell substantially in 2003, mainly reflecting higher short-term financial inflows and a reduction in banks’ net foreign assets—by almost $9 billion in 2003.
  - During the first half of 2004, there were renewed net capital outflows, mainly because of a reversal of short-term flows, although renewed reserve accumulation since May suggests outflows have waned again.
- Central Bank of Russia (CBR) actions and reserves:
  - The CBR has increased its net international reserves by over $40 billion since early 2003.
  - Gross international reserves stood at $88 billion in mid-2004 (around seven months of imports and more than 200 percent of short-term external debt).
  - The CBR has intervened heavily to slow the ruble’s appreciation and has sterilized only a small part of its interventions.
- Monetary and fiscal interactions:
  - Base money growth accelerated during 2003 and is still running at around 40 percent year-on-year.
  - Policy interest rates have been very low since early 2003.
  - A relaxation of fiscal policy has limited the extent to which higher government deposits at the CBR could sterilize interventions.

### Outlook
- Growth projections and balance of payments:
  - Growth is expected to remain robust over the near term on current assumptions that oil prices will stay relatively high and that negative repercussions from recent events in the banking sector are temporary.
  - The balance of payments should remain strong too, notwithstanding some volatility in short-term capital flows.
- Risks:
  - External vulnerabilities are likely to remain low, but there are significant downside risks associated with the oil price outlook.
  - Additional risks include the possibility that further turmoil in the banking system or the handling of the Yukos affair could damage confidence.
- Inflation and exchange rate:
  - On planned policies, the pace of disinflation is likely to remain sluggish.

### Policy discussions and staff recommendations
- Fiscal policy:
  - Plans to relax fiscal policy while burdening monetary policy with the task of limiting real ruble appreciation point to increasing policy contradictions.
  - Staff recommended that there should be no further loosening of fiscal policy at this point in the economic cycle.
  - Authorities acknowledged risks but stressed benefits of higher spending on reforms.
- Monetary policy:
  - Staff recommended monetary policy should focus on reducing inflation, unburdened of exchange rate objectives.
  - CBR officials agreed that fiscal policy is the appropriate instrument for limiting real appreciation, but with little prospect of fiscal tightening and strong political concerns about real appreciation, the CBR would maintain its dual targeting regime—seeking to reduce inflation while limiting ruble appreciation.
- Banking sector and financial stability:
  - Recent efforts to press ahead with reforms in the banking sector triggered some deposit runs; the central bank responded with a substantial general liquidity injection and extension of household deposit insurance to all banks.
  - Recent turmoil highlights the need for the CBR to have strong political support and more effective instruments to strengthen banking supervision and deal with problem banks.
  - Following years of regulatory forbearance and limited reforms, the authorities recognized that the current favorable macroeconomic environment was likely masking problems that would only emerge when oil prices drop; problems need to be addressed now while systemic vulnerabilities are manageable.
- Structural reforms:
  - Structural reform plans are ambitious but implementation has yet to be initiated.
  - Some senior officials shared staff’s concern that high oil prices and strong growth might be causing complacency about reforms.
  - Officials recognized that, in an environment of lower oil prices, strong growth could only be maintained if reforms are accelerated.

### Key quantitative indicators (as reported)
- GDP growth: rose to 7¼ percent in 2003; first half of 2004 suggests growth around 7½ percent.
- Core inflation: 10–11 percent since mid-2002.
- Real exchange rate appreciation: nearly 10 percent year-on-year.
- Current account surplus: stable at 8–9 percent of GDP for the past two years.
- Change in banks’ net foreign assets: reduction by almost $9 billion in 2003.
- CBR net international reserve accumulation: over $40 billion since early 2003.
- Gross international reserves: $88 billion in mid-2004 (around seven months of imports and more than 200 percent of short-term external debt).
- Base money growth: around 40 percent year-on-year.

*Source: _cr04314 - Executive Summary*

### 6.      Bank credits are rising fast. Broad money is recovering rapidly, with a notable shift

### 6.      Bank credits are rising fast. Broad money is recovering rapidly, with a notable shift

### Banking and monetary developments
- Bank credits to the economy increased by about 45 percent during the past 12 months, and over 200 percent since the beginning of 2001.
- Broad money is recovering rapidly, with a notable shift from foreign currency to ruble deposits, and with a reduction in foreign currency holdings outside the banking system.
- Broad money and bank credits to the economy still amount to only 27 percent and 22 percent of GDP, respectively, indicating low monetization and intermediation compared to other emerging market economies.
- The surge in credit has coincided with booming real estate and, until recently, stock market prices.
- Reserve accumulation is expected to be substantial, at around $20 billion this year.
- Recent regulatory actions by the CBR included:
  - Introduction of deposit insurance extending coverage for household deposits up to Ruble 100,000 to all qualified banks.
  - Enforcement that banks not meeting strict prudential eligibility criteria will lose their license to take retail deposits by September 2005.
  - Liberalization of capital flows, with the CBR empowered to impose unremunerated deposit requirements on capital flows; the CBR introduced moderate deposit requirements on both inflows and outflows with effect from August 1, 2004.
  - Halving of reserve requirements to 3½ percent amid bank runs and liquidity problems.
  - Immediate extension of deposit insurance to all banks, even those that fail to meet the eligibility criteria for the new scheme; deposits in such banks will be guaranteed by the CBR subject to the same terms as the general scheme, with any unrecoverable cost to the CBR eventually becoming a charge on the budget.

### Banking system soundness and vulnerabilities
- Soundness indicators (based on Russian Accounting Standards) show banks overall profitable and adequately provisioned and capitalized, with improving asset quality.
- Structural weaknesses noted:
  - High sensitivity of the economy and banking system to oil prices.
  - Concentrated exposures, many to related parties.
  - Non-transparent operating environment with poor corporate governance and risk management.
  - Weak creditor rights and unreliable financial statements.
  - Inadequate bank bankruptcy law and a history of supervisory and prudential forbearance.
  - Continued dominance of Sberbank and no progress on a strategy for its future.
- Recent turmoil: since the closure of a bank in May, nine other private banks—two among the top 25 in terms of assets—publicly acknowledged liquidity problems and three have been closed. After Guta Bank suspended operations because of a deposit run in July, the CBR supported a purchase of Guta Bank by state-owned Vneshtorgbank (VTB).

### Fiscal developments and oil price adjustment
- General government recorded a surplus of about 1 percent of GDP in 2003, only ½ percentage point higher than in 2002, despite acceleration in GDP and significantly higher oil taxes.
- Measured at a constant oil price of $20 per barrel, the general government deficit increased by 1 percent of GDP, to about 1¼ percent, continuing the relaxation underway since 2001.
- Staff analysis: a $1 decline in the oil price would reduce revenues by ⅓ percent of GDP (direct effect). At a Urals oil price of $20 a barrel, the general government would have run a deficit of 1¼ percent of GDP in 2003, compared with the recorded surplus of 1 percent of GDP at the actual Urals oil price of $27 a barrel.
- Indirect effects via GDP: estimates that a reduction in oil prices of $1 a barrel would reduce GDP in the short term by ¼–½ percent; given general government revenues are about one third of GDP, a conservative estimate of the indirect impact on the budget of a $20 oil price in 2003 would be in the range ½–1 percent of GDP. Total impact on the budget—direct plus indirect—of a $1 change in the oil price could be nearly ½ percent of GDP.
- The 2004 budget envisages planned tightening of almost 1 percent of GDP, to be achieved by reducing non-interest expenditures; this would nearly balance the budget at an oil price of $20 per barrel.
- Creation of an oil stabilization fund: revenues arising from oil prices above $20 per barrel are accumulated in the fund.
- Draft 2005 budget entails reduced saving of oil revenues and an attendant relaxation of fiscal policy.

### Fiscal policy outlook and government plans
- Pressures for fiscal relaxation to finance reforms are increasing; government plans include cutting the unified social tax (UST) and monetizing many in-kind benefits at a cost to the 2005 budget of about 2 percent of GDP.
- The UST cut is estimated to reduce revenues of the extrabudgetary funds by 1¼ percent of GDP; the draft budget envisages an increased federal transfer to the pension fund to cover about half of this shortfall.
- Federal spending will also increase by about ¾ percent of GDP to finance the monetization of in-kind benefits.
- Officials stated that whereas all revenues arising from oil prices above $20 a barrel are currently being saved in the stabilization fund, only half of such revenues will be saved once the existing cap on the fund of Ruble 500 billion (about 2¾ percent of GDP) is reached. This will happen by mid-2005 under the budget’s oil price assumption of $26 a barrel, and much earlier if prices remain at current levels.
- Of the half not saved in the stabilization fund, one half will be transferred to the pension fund to cover the UST cut shortfall; the other half will be saved outside the stabilization fund and could be used for early repayment of debt.
- The draft 2005 budget assumes relaxation at constant oil prices of only about ¼ percent of GDP, reflecting significant expenditure savings in other areas, mostly at the local government level.

### Structural reform progress and regulatory actions
- Limited progress on structural reforms over two years: pension system and electricity sector reforms scaled down; reforms of Gazprom, public administration, and social and military sectors effectively stalled.
- Major legislation adopted: introduction of deposit insurance and liberalization of capital flows.
- Increased enforcement of prudential standards and AML/CFT legislation by the CBR has contributed to recent bank sector turmoil.
- State-owned banks have been seen as a safe haven during private bank turmoil.

### Outlook, growth projections, and risks
- Staff projects GDP growth of 7¼ percent in 2004, slowing to 6½ percent in 2005, on the assumption of a Urals oil price of $30 a barrel in 2004, and $28½ in 2005.
- Authorities project 6½ percent growth in 2004 and 6 percent in 2005, based on Urals oil price assumptions of $29 and $26 a barrel respectively.
- Growth is assumed to slow over the medium term to about 5 percent (trend), reflecting that perhaps 2 percentage points of last year’s growth was due to exceptionally high oil prices and assuming steady progress on structural reforms.
- Balance of payments: strong near-term outlook, with reserve accumulation around $20 billion in the year; current account surplus likely to decline as oil and commodity prices return to normal levels; net private capital inflows expected to increase over time as reforms take hold.
- External debt outlook: public external debt, net of reserves, has fallen close to zero (compared with $140 billion in 1998). Gross public external debt, currently around 20 percent of GDP, projected to fall below 10 percent by 2007; total external debt projected to stabilize at just under 30 percent of GDP.
- Downside risks:
  - Oil price decline.
  - Turmoil in the banking system undermining investment and capital flows.
  - Handling of the Yukos affair potentially impacting investment and capital flow volatility, possibly disrupting oil production and damaging confidence if asset sales are not transparent and at fair market prices.
- Assumptions for the outlook include successful restoration of confidence in the banking system and that handling of the Yukos affair does not lead to widespread investor concerns about transparency and even-handedness of law enforcement.

### Policy advice and implications
- Fund advice emphasized:
  - Need to reduce inflation to a low and stable rate.
  - Gear fiscal policy to the economic and oil price cycles to limit pressures for real ruble appreciation.
  - Implement strong structural reforms to improve the investment climate and reduce dependence on the natural resource sector.
  - Strengthen supervisory and regulatory framework for banks.
- Assessment: progress has been mixed—pressures from high energy and commodity prices have led to fiscal relaxation pressures, slow disinflation, and weakened resolve on reforms.
- Authorities target headline inflation of 8–10 percent in 2004 and 6½–8½ percent in 2005, and expect to limit real effective ruble appreciation to 3–7 percent a year; staff judged that without policy changes, authorities will struggle to lower core inflation substantially while reducing the pace of real ruble appreciation.

*Source: IMF staff report text (section provided).*

### 23.      Staff found that the relaxation could be significantly higher than assumed in the

### 23. Staff found that the relaxation could be significantly higher than assumed in the

### Fiscal stance, budget risks, and policy recommendations
- Staff judged the draft budget’s assumed expenditure savings as unrealistic, especially the assumption that regional and local governments will cut spending by around 1½ percent of GDP and run a surplus of ¾ percent of GDP.
- Given a weak framework for controlling spending at lower levels of government, staff argued sub-national governments should be assumed to balance their budgets, at best.
- Overall, staff expected the draft budget to entail a relaxation of the general government stance at constant oil prices of 1–1¼ percent of GDP in 2005 (Tables 7–8).
- Staff argued fiscal policy should not add stimulus at this point in the economic cycle, given existing macroeconomic tensions and a favorable outlook for private demand and the balance of payments.
- Additional measures yielding savings or revenues of 1–1¼ percent of GDP in 2005 were therefore needed.
- Revenues from oil prices above the current benchmark of $20 per barrel should continue to be saved in the stabilization fund and the cap on the fund should be lifted.
- Ministry of finance officials acknowledged increased macroeconomic risks and the challenge of achieving assumed expenditure restraint at local and regional levels, but noted limited scope for other savings and insisted UST and expenditure reforms could not be scaled back at this stage.
- Authorities expected tax cuts to yield early benefits; some senior officials expected the cut in UST to have a stronger impact on the revenue base and to quickly lead to higher investment and GDP growth. Staff warned this optimism was not supported by international experience and that the impact on investment depends on broader reforms to improve the investment climate.
- Staff welcomed efforts to eliminate unfunded mandates but questioned whether monetization of in-kind benefits was sufficiently well targeted.
- Staff called for clarified policy objectives: increasing support for immediate fiscal relaxation to finance reforms conflicts with authorities’ unwillingness to accept real ruble appreciation.
- Staff argued some gradual real appreciation is inevitable and desirable (Box 4), but emphasized the need for consistency between the fiscal stance and exchange rate policy; relaxing fiscal policy while burdening monetary policy with controlling the real exchange rate risks contradictions in the policy mix.
- Medium-term challenges: further reductions in the non-oil tax burden beyond 2005 and the need to mobilize additional resources for reforms and improvements in social services will keep pressures on public resources high.
- Public debt is currently only around 25 percent of GDP and set to decline further; staff saw little cause for concern about debt sustainability even under a scenario with markedly lower oil prices (Table 9).
- Staff recognized a case for spending more oil revenues on long-term structural reforms once cyclical pressures ease, but cautioned that medium-term fiscal loosening should be tempered by:
  - substantial unfunded pension liabilities;
  - contingent liabilities, including those resulting from the recent introduction of deposit insurance;
  - the need to ensure fiscal policy does not add to volatility in GDP in a highly oil dependent economy.

### Monetary policy: targets, constraints, and staff advice
- CBR official targets:
  - headline inflation of 10 percent by end-2004;
  - headline inflation of 7½ percent by end-2005.
- CBR has no target for core inflation; some senior officials doubted much progress in reducing core inflation as long as pressures to resist ruble appreciation persist.
- CBR will continue dual targeting: seeking to reduce inflation and stem ruble appreciation. Officials acknowledged monetary policy could resist real ruble appreciation only in the short term, though they believed this to be longer than the mission did.
- Officials viewed fiscal tightening as the appropriate instrument for pursuing real exchange rate objectives, but with little prospect of fiscal tightening they could not accept staff’s recommendation to prioritize the inflation target and reduce or cease interventions even if interventions threatened the inflation target.
- The official monetary policy guidelines for 2005 would likely again include an explicit limit for real ruble appreciation as a target for monetary policy.
- Sterilization:
  - CBR officials argued sterilization would be largely ineffective as attendant upward pressure on interest rates would increase inward capital inflows.
  - The mission saw somewhat more scope for sterilization but agreed it would not be effective on a large scale.
- CBR officials believed fiscal relaxation would make it difficult to meet the inflation target and considered the proposed relaxation in the draft 2005 budget relatively modest.
- Officials were concerned weakening of the stabilization fund mechanism reduced safeguards against spending higher-than-expected oil revenues; the budget’s oil price assumption was conservative, suggesting revenues might be higher than budgeted.
- If such revenues were spent—or if spending at regional and local levels was higher than assumed—the end-2005 inflation target might not be met.
- Staff position:
  - Monetary policy was too accommodating of inflationary pressures from fiscal relaxation; such pressures would intensify unless oil prices fell significantly.
  - Staff argued the cost to the economy of high inflation was not sufficiently recognized and that the cost of appreciation was exaggerated.
  - With some real appreciation inevitable, staff argued the choice for monetary policy is whether this should take place through higher inflation or nominal ruble appreciation.
  - Staff urged the CBR to take advantage of the disinflationary impact of nominal appreciation to set core inflation on a more ambitious downward course, and to commit not to let the inflation target give way to exchange rate considerations.
  - Staff called for the CBR to focus on core inflation—although it might continue officially to target headline inflation—and urged that administered prices not be used to control inflation.
- CBR officials believed nominal ruble appreciation would encourage capital inflows; staff argued making clear a firm monetary focus on reducing inflation would increase short-term exchange rate uncertainty and discourage speculative flows.
- With a fundamentally strong balance of payments and a still high rate of inflation implying large interest rate differentials, staff warned fundamentals pointed to continued pressures for medium and long-term capital inflows—an argument for faster disinflation.
- Unremunerated deposit requirements will be imposed on capital flows under the new foreign exchange law to control inflows of volatile short-term capital to weak banks and to help stem ruble appreciation.
- Staff questioned effectiveness of deposit requirements: experience suggests they mainly raise the cost of capital (especially for SMEs) and have transitory impact on inflows; they should be temporary and not a substitute for a more flexible exchange rate policy. Strong banking supervision was highlighted as a more effective instrument to address inflows to weak banks.
- CBR intends to move to inflation targeting over the medium term; necessary conditions—including technical requirements identified by MFD—were likely to be in place in 2–3 years, at the earliest.

### Financial sector vulnerabilities and recommended reforms
- CBR is determined to enforce stricter prudential standards; the recent closure of a small bank reflected this (the first closure since the 1998 crisis of a bank that had not already defaulted).
- The forthcoming comprehensive review of banks wanting to join the new deposit insurance scheme and enforcement of new AML/CTF legislation provide opportunities to implement stricter standards; additional closures were expected.
- Banking system risks have increased due to rapid credit growth, larger exposure to oil price related risk, and the economy’s dependence on oil prices.
- CBR stress tests found that a shock as severe as the 1998 crisis would result in losses of 4 percent of GDP, based on end-2003 data; the FSAP test on the basis of end-2001 data had estimated losses of 3 percent of GDP.
- Liquidity risk has increased: while liquidity remains high system-wide, lack of an effective interbank market, of assets that can serve as collateral, and lack of transparency about ownership and activities mean individual banks may be vulnerable to depositor nervousness.
- CBR argued systemic and macroeconomic vulnerabilities are limited, noting:
  - the monetization of the economy is still relatively low;
  - about ⅔ of household deposits are with CBR-owned Sberbank and a few other state-owned banks, which enjoy a government guarantee and are viewed as safe havens;
  - external vulnerabilities have declined to low levels: the public sector’s debt, net of foreign reserves, is close to zero, and the corporate sector’s debt is limited.
- Recent turbulence highlighted the urgent need to sharpen instruments to address banking sector problems. Key needs identified:
  - rapid and certain payouts under deposit insurance to preserve its stabilizing role;
  - passage of amendments to the bank bankruptcy law to provide more certain and speedy resolution processes, allowing effective CBR intervention with minimum implications for confidence;
  - broaden the range of eligible collateral to facilitate targeted liquidity to sound banks experiencing deposit runs;
  - CBR transparency and expeditious action when closing banks.
- Staff concerned recent events might lead to regulatory forbearance; limited progress in implementing banking reforms since the 1998 crisis was noted. Staff stressed tackling problems now while manageable and resources to recapitalize banks exist.
- Medium-term reform priorities needing acceleration:
  - move to risk-based supervision;
  - improve governance and transparency of bank ownership;
  - adopt International Financial Reporting Standards.
- Staff concerned the authorities’ medium-term action plan did not give priority to a strategy for state-owned banks (notably Sberbank); overdominance of state-owned banks could stifle development of a dynamic and competitive banking sector.

### Key statistics on the banking system (as reported)
- Deposits 21.2
  - Enterprise deposits 9.5
    - Sberbank, VEB and VTB 2.0
    - Other banks 7.6
  - Household deposits 11.6
    - Sberbank, VEB and VTB 7.4
    - Other banks 4.3
- Banking system assets 42.2
  - Sberbank, VEB and VTB 22.5
  - Other banks 19.7
- Credit to the economy 22.4
  - Sberbank, VEB and VTB 6.5
  - Other banks 15.8
- Memorandum items:
  - Number of banks 1,329
    - State-owned 1/6
    - Foreign-owned 2/128
    - Other 1,195

*Source: IMF staff report (content unit: _cr04314 - 23.      Staff found that the relaxation could be significantly higher than assumed in the).*

### 44.      The authorities intend to undertake a broadly-based acceleration of reforms.

### _cr04314 - 44.      The authorities intend to undertake a broadly-based acceleration of reforms.

### Reform priorities and scope
- Authorities intend a broadly-based acceleration of reforms, with main priorities including:
  - General administrative reforms.
  - Comprehensive reforms of the health, education, housing, and military sectors.
  - Tax and banking reforms (discussed elsewhere in the source).
  - Ongoing reforms of the natural monopolies.
- Officials of the ministry of economy and trade: the new government decided on broad priorities but was still elaborating programs and was not ready to discuss details, including timing of key steps, with the mission.
- Common features of sectoral reforms:
  - Establishment of performance targets.
  - Shift to performance based budgeting.
  - Some reforms involve eliminating provisions establishing general entitlements to housing and social services inherited from central planning.

### Investment climate and public sector reform
- Overarching objective: reduce dependence on oil by improving the investment climate, beginning with public sector reforms.
- Rationale:
  - Public sector’s large claim on resources and pervasive interference in the economy, including at local and regional levels, deter private investment, particularly for small and medium-sized enterprises.
  - Priority is therefore given to public sector reforms, with an increasing focus on expenditure reforms as main tax reforms near completion.
- General administrative reforms aim to:
  - Streamline all levels of government.
  - Eliminate overlapping functions.
  - Reduce the role of government in the economy.

### Sectoral reforms with investment-climate implications
- Housing reforms:
  - Include development of the mortgage market.
  - Important for labor mobility; lack of mobility produces large regional income inequality and limits potential GDP growth by causing regional labor shortages.
- Banking sector reforms:
  - Key to improving a relatively low level of financial intermediation that harms small and medium-sized enterprises.
- WTO accession:
  - Drive for early WTO accession expected to catalyze key reforms, promote competition and reduce rent-seeking.
  - Officials reported bilateral negotiations regarding WTO accession completed with partners accounting for three-quarters of trade; issues outstanding on market access for automobiles, aircraft and agricultural products with remaining countries; liberalization of the services sector remains outstanding.
  - Russia is pursuing liberalization within the Eurasian Economic Community; customs agreement expected to come fully into force only after WTO accession.
- Staff reminder: need for speedy removal of all exchange restrictions subject to Article VIII.

### Staff appraisal: progress, risks, and policy guidance
- General assessment:
  - Staff welcomed the reform thrust and focus on the investment climate, but concerned about lack of specificity and lack of support for implementation.
  - Staff shared priorities, especially reducing public sector interference and corruption, but noted many reforms remain to be elaborated and politically/technically difficult.
  - Many reform objectives are not new; preparation or implementation has been stalled because of resistance from vested interests.
  - Limited progress during past two years; concern that high oil prices and robust growth may be causing complacency about reforms.
- Specific risks and concerns:
  - In some areas (e.g., Gazprom) no agreement on basic concept; in others (military, housing, education, health) agreement on broad objectives but not detailed plans; pension and electricity reforms being scaled back or subject to protracted implementation periods.
  - Handling of the Yukos case could damage the investment climate by raising concerns about transparency, even-handedness, and political impartiality of judicial and regulatory systems.
- Macroeconomic tensions:
  - Fiscal relaxation has exacerbated pressures for real ruble appreciation from strong balance of payments; monetary and exchange rate policies have resisted appreciation at cost of entrenched inflation.
  - Current drive for further fiscal relaxation to finance reforms, while the CBR resists appreciation, suggests rising contradictions.
- Fiscal policy guidance:
  - Fiscal policy should not provide additional stimulus at this point in the economic cycle.
  - Additional measures yielding 1–1¼ percent of GDP should be included in the draft 2005 budget to ensure an unchanged fiscal stance.
  - Taxes from oil prices above $20 a barrel should continue to be fully saved in the stabilization fund.
  - Once cyclical pressures ease, there may be a case for spending more on carefully elaborated long-term reforms, implying a larger deficit at constant oil prices; a small deficit over the full oil price cycle would be sustainable given low public sector debt and good growth prospects.
  - If private demand grows strongly, fiscal policy would need to be more restrained and savings in the stabilization fund higher.
- Monetary policy guidance:
  - Monetary policy should focus on reducing inflation, unburdened of exchange rate considerations.
  - With continued recovery in money demand, scope exists for some unsterilized interventions while keeping inflation on a downward path, but these should cease or be scaled back and the ruble allowed to appreciate if they threaten the inflation target.
  - Making clear that the CBR will focus on inflation and allow ruble appreciation may increase short-term exchange rate variability and discourage speculative capital inflows.
  - Unremunerated deposit requirements will only stem capital inflows temporarily, if at all, and are not an alternative to a more flexible exchange rate policy.
- Inflation targets:
  - The early reduction in inflation to 3 percent called for by President Putin is desirable and achievable.
  - CBR’s headline inflation target is 7½ percent by end-2005; staff stresses the need for a corresponding decline in core inflation.
  - Using administered prices to bear down on inflation must be resisted.
- Banking sector and crisis management:
  - Recent turmoil underscores urgency of strengthening crisis management tools while closing unsound banks.
  - Forbearance would be regrettable; extension of interim deposit insurance to all banks increases moral hazard.
  - CBR must enforce sound prudential standards in assessing eligibility for participation in the deposit insurance scheme.
  - A more effective crisis management framework, including prompt depositor payout under the deposit insurance scheme, would help limit contagion.
  - Staff prefers that negative repercussions surface now while systemic vulnerabilities are manageable.
- Overall view:
  - Government’s reform agenda is generally well-focused with priority on improving the investment climate for small and medium-sized enterprises, reform of government, banking reforms, housing reforms, and early WTO accession.
  - But there is a gap between intentions and achievements; momentum slowed after 2000–01 and many reforms face resistance from vested interests.
  - High oil prices and strong growth should be viewed as an opportunity, not grounds for complacency, to carry out structural reforms needed to sustain medium-term growth.

### Box 5 — Medium-term Structural Fiscal Reform (key points)
- Strategy objectives to diversify the economy and double GDP in ten years:
  - Cut the tax burden on the non-oil sector by about 1 percentage point of GDP a year for the next few years; redistribute the tax burden from the non-oil to the oil sector.
  - Increase taxation of oil sector rents associated with exceptionally high oil prices; saving windfall oil revenues will play a stabilizing role as federal fiscal revenues become increasingly dependent on oil.
  - Rationalize public expenditure to eliminate remaining legacy of subsidies and inefficiency.
- Requirements: measures in tax and expenditure policy, fiscal federalism, and quasi-fiscal activities.
- Revenues:
  - Unified social tax: authorities decided to cut the top rate from 36 percent to 26 percent starting next year, at an estimated cost of 1–1½ percent of GDP. Staff notes importance that this does not threaten pension system sustainability.
  - VAT: current rates 18 percent and 10 percent; authorities plan to unify rates, probably at 16 percent, in 2006 or 2007; unification will reduce distortions and simplify tax administration. Staff cautioned against further rate reductions, arguing focus should be on cutting other less efficient taxes.
  - Oil taxes: authorities increased marginal rates of export and extraction taxes when the price of Urals oil is above $25 a barrel, effective in 2005.
  - Tax administration: poor rules on transfer pricing are a key weakness, especially in the oil sector; amendment to the tax code is needed to eliminate abuses.
- Expenditure:
  - Long-term goal: reduce size of government and rationalize expenditures.
  - Civil service and public administration reforms are essential to improve governance and raise efficiency of public expenditure; government has started reorganizing ministries and agencies but much work remains.
  - Reforms in military, health, and education sectors are urgent to improve efficiency of services.
  - Energy pricing reforms are long overdue to reduce quasi-fiscal activities and promote reforms; authorities committed to increase domestic gas and electricity prices over the next few years but staff concerned pace might be too slow because authorities see restraint of administered price increases as a way to reduce headline inflation.
  - Fundamental decisions needed to ensure long-term sustainability of the pension system given projected aging of the population.
  - State-owned housing and subsidized communal services companies are inefficient and financially nonviable; reforms necessary to rationalize public expenditure, especially at local government level; housing reforms would reduce obstacles to intra-regional labor mobility.
- Other reforms:
  - Intergovernmental relations: expenditure responsibilities among different layers of government remain inefficient and nontransparent; a major reform is underway.
  - Plan to reduce unfunded mandates and monetize some in-kind benefits is an important step toward transparency; needs to be accompanied by hardening of budget constraints of public enterprises providing the services to ensure fiscal neutrality.
  - Budget process: government started reform aimed at improving efficiency in formulation and administration of the budget, including introduction of performance-based budgeting.
- Overall evaluation:
  - Staff broadly supports the strategy but is concerned that strong growth and high oil prices may weaken resolve to press ahead with reforms.
  - Staff considers broad structural reforms, not redistributive tax cuts, as the best way to promote economic diversification and sustained growth.
  - In line with fiscal transparency ROSC conclusions, staff would like to see higher priority given to reforms of major public enterprises and reduction of associated quasi-fiscal activities.

*Source: IMF staff report excerpt titled "_cr04314 - 44.      The authorities intend to undertake a broadly-based acceleration of reforms."*

### 58.      It is proposed that the next Article IV consultation for Russia be conducted on the

### _cr04314 - 58.      It is proposed that the next Article IV consultation for Russia be conducted on the

### Proposed consultation timing
- It is proposed that the next Article IV consultation for Russia be conducted on the standard 12-month cycle.

### Selected Macroeconomic Indicators (Table 1) — headline figures and projections
- Real GDP: 2001: 5.1, 2002: 4.7, 2003: 7.3, 2004: 7.3, 2005: 6.4
- Consumer prices (period average): 2001: 21.5, 2002: 15.8, 2003: 13.7, 2004: 10.3, 2005: 8.6
- Consumer prices (end of period): 2001: 18.6, 2002: 15.1, 2003: 12.0, 2004: 10.0, 2005: 7.5
- GDP deflator: 2001: 16.5, 2002: 15.7, 2003: 14.2, 2004: 12.9, 2005: 7.4
- General government overall balance (commitment basis): 2001: 2.7, 2002: 0.6, 2003: 1.1, 2004: 3.1, 2005: 1.7
- Revenue (percent of GDP): 2001: 37.3, 2002: 37.6, 2003: 36.6, 2004: 37.0, 2005: 35.3
- Expenditures (percent of GDP): 2001: 34.6, 2002: 37.0, 2003: 35.5, 2004: 33.9, 2005: 33.6
- Primary balance (percent of GDP): 2001: 5.4, 2002: 2.7, 2003: 2.7, 2004: 4.4, 2005: 3.1
- Overall balance at constant oil price (at an oil price of $20 per barrel): 2001/1.8, 2002:-0.3, 2003:-1.3, 2004:-0.5, 2005:-1.6
- Federal government overall balance (commitment basis): 2001: 2.7, 2002: 1.3, 2003: 1.5, 2004: 3.0, 2005: 2.5
- Base money (annual percent change): 2001: 38.1, 2002: 30.4, 2003: 49.6, 2004: 24.0, 2005: 23.6
- Ruble broad money (annual percent change): 2001: 40.1, 2002: 32.3, 2003: 51.6, 2004: 35.3, 2005: 18.3
- Export volumes (annual percent change): 2001: 2.4, 2002: 6.5, 2003: 13.8, 2004: 7.1, 2005: 4.2
  - Oil export volumes: 2001: 9.1, 2002: 15.5, 2003: 17.5, 2004: 9.0, 2005: 8.0
  - Gas export volumes: 2001:-6.7, 2002: 3.0, 2003: 2.1, 2004: 2.0, 2005: 2.0
  - Non-energy export volumes: 2001: 1.8, 2002: 1.5, 2003: 14.9, 2004: 7.0, 2005: 1.7
- Import volumes (annual percent change): 2001: 23.3, 2002: 10.8, 2003: 20.9, 2004: 10.7, 2005: 10.5
- Total exports, fob (in billions of U.S. dollars): 2001: 101.9, 2002: 107.2, 2003: 135.9, 2004: 174.0, 2005: 181.0
- Total imports, fob (in billions of U.S. dollars): 2001:-53.8, 2002:-61.0, 2003:-75.4, 2004:-95.5, 2005:-113.7
- External current account (in billions of U.S. dollars): 2001: 33.4, 2002: 30.9, 2003: 35.8, 2004: 46.8, 2005: 31.5
- External current account (in percent of GDP): 2001: 10.9, 2002: 9.0, 2003: 8.3, 2004: 8.4, 2005: 4.8
- Gross international reserves (in billions of U.S. dollars): 2001: 34.5, 2002: 47.8, 2003: 76.9, 2004: 97.0, 2005: 115.5
- Reserves in months of imports: 2001: 5.0, 2002: 5.6, 2003: 7.1, 2004: 7.6, 2005: 8.5
- Reserves in percent of short-term debt: 2001: 147, 2002: 156, 2003: 235, 2004: 252, 2005: 293
- Nominal GDP (in billions of rubles): 2001: 8,944; 2002: 10,834; 2003: 13,285; 2004: 16,090; 2005: 18,382
- Nominal GDP (in billions of U.S. dollars): 2001: 307; 2002: 346; 2003: 433; 2004: 560; 2005: 656
- Exchange rate (rubles per U.S. dollar, period average): 2001: 29.2, 2002: 31.3, 2003: 30.7
- World oil price (U.S. dollars per barrel, WEO): 2001: 24.3, 2002: 25.0, 2003: 28.9, 2004: 34.5, 2005: 32.8
- Real effective exchange rate (average percent change): 2001: 18.7, 2002: 3.7, 2003: 3.5, 2004: 9.3, 2005: 11.5

*Source: Russian authorities, and Fund staff estimates.*

### Macroeconomic Framework (Table 2) — savings, government accounts, growth and reserves projections
- National savings (percent of GDP): 2001: 5.8, 2002: 3.8, 2003: 3.9, 2004: 6.1, 2005: 4.7
- National savings - investment (current account, percent of GDP): 2001: 10.9, 2002: 9.0, 2003: 8.3, 2004: 8.4, 2005: 4.8; projections: 2006: 2.4, 2007: 1.3, 2008: 0.7, 2009: 0.2
- General government revenues (percent of GDP): 2001: 37.3; 2002: 37.6; 2003: 36.6; 2004: 37.0; 2005: 35.3; 2006: 33.6; 2007: 33.0; 2008: 32.5; 2009: 32.3
- General government expenditure (percent of GDP): 2001: 34.6; 2002: 37.0; 2003: 35.5; 2004: 33.9; 2005: 33.6; 2006: 32.7; 2007: 32.6; 2008: 32.2; 2009: 32.3
- Overall balance (percent of GDP): 2001: 2.7; 2002: 0.6; 2003: 1.1; 2004: 3.1; 2005: 1.7; projections: 2006: 0.9; 2007: 0.5; 2008: 0.3; 2009: 0.1
- Primary balance (percent of GDP): 2001: 5.4; 2002: 2.7; 2003: 2.7; 2004: 4.4; 2005: 3.1; projections: 2006: 1.8; 2007: 1.2; 2008: 0.9; 2009: 0.7
- External current account (in billions of U.S. dollars): 2001: 33.4; 2002: 30.9; 2003: 35.8; 2004: 46.8; 2005: 31.5; projections: 2006: 18.3; 2007: 10.9; 2008: 5.9; 2009: 2.1
- Official reserves (in billions of U.S. dollars): 2001: 34.5; 2002: 47.8; 2003: 76.9; 2004: 97.0; 2005: 115.5; projections: 2006: 127.6; 2007: 137.0; 2008: 145.8; 2009: 160.1
- Official reserves (in months of imports): 2001: 5.0; 2002: 5.6; 2003: 7.1; 2004: 7.6; 2005: 8.5; projections: 2006: 8.9; 2007: 9.0; 2008: 8.7; 2009: 8.8
- Real GDP growth (projections): 2004: 7.3; 2005: 6.4; 2006: 5.5; 2007: 5.0; 2008: 5.0; 2009: 5.0
- CPI Inflation, end of period (projections): 2004: 10.0; 2005: 7.5; 2006: 6.0; 2007: 4.0; 2008: 3.0; 2009: 3.0
- Nominal GDP (billions of U.S. dollars, projections): 2004: 560; 2005: 656; 2006: 748; 2007: 827; 2008: 899; 2009: 972

*Source: Staff estimates and projections based on official data.*

### Balance of Payments Projections (Table 3) — detailed external flows and projections
- Current account (percent of GDP): 2001: 10.9, 2002: 9.0, 2003: 8.3, 2004: 8.4, 2005: 4.8; projections: 2006: 2.4, 2007: 1.3, 2008: 0.7, 2009: 0.2
- Trade balance (percent of GDP): 2001: 48.1, 2002: 46.3, 2003: 60.5, 2004: 78.4, 2005: 67.4; projections: 2006: 57.4, 2007: 53.8, 2008: 52.8, 2009: 52.4
- Exports (billions of U.S. dollars): 2001: 101.9, 2002: 107.2, 2003: 135.9, 2004: 174.0, 2005: 181.0; projections: 2006: 179.6, 2007: 182.5, 2008: 188.6, 2009: 193.4
  - Non-energy exports (percent of GDP): 2001: 50.2, 2002: 51.8, 2003: 62.2, 2004: 79.6, 2005: 83.1; projections: 2006: 82.9, 2007: 84.1, 2008: 86.4, 2009: 88.8
  - Energy exports (percent of GDP): 2001: 51.7, 2002: 55.5, 2003: 73.7, 2004: 94.3, 2005: 80.9; projections: 2006: 96.7, 2007: 98.4, 2008: 102.1, 2009: 104.6
    - Oil (percent of GDP): 2001: 34.0, 2002: 39.6, 2003: 53.7, 2004: 70.7, 2005: 72.5; projections: 2006: 72.2, 2007: 74.7, 2008: 78.6, 2009: 81.2
    - Gas (percent of GDP): 2001: 17.8, 2002: 15.9, 2003: 20.0, 2004: 23.7, 2005: 25.5; projections: 2006: 24.5, 2007: 23.7, 2008: 23.5, 2009: 23.4
- Imports (billions of U.S. dollars): 2001:-53.8, 2002:-61.0, 2003:-75.4, 2004:-95.5, 2005:-113.7; projections: 2006:-121.8, 2007:-128.7, 2008:-136.1, 2009:-151.0
- Services (net, percent of GDP): 2001:-13.9, 2002:-15.0, 2003:-24.3, 2004:-31.2, 2005:-35.4; projections: 2006:-39.1, 2007:-42.4, 2008:-46.1, 2009:-39.8
  - Nonfactor services (percent of GDP): 2001:-8.4, 2002:-9.1, 2003:-11.1, 2004:-14.4, 2005:-18.1; projections: 2006:-20.5, 2007:-22.4, 2008:-24.3, 2009:-27.6
  - Factor services (percent of GDP): 2001:-5.5, 2002:-6.0, 2003:-13.2, 2004:-16.8, 2005:-17.3; projections: 2006:-18.5, 2007:-20.0, 2008:-21.8, 2009:-12.3
    - Public sector interest (percent of GDP): 2001:-6.6, 2002:-5.6, 2003:-5.2, 2004:-5.1, 2005:-4.9; projections: 2006:-4.6, 2007:-4.5, 2008:-4.4, 2009:-4.0
    - Other factor services (percent of GDP): 2001: 1.1, 2002:-0.3, 2003:-7.9, 2004:-11.7, 2005:-12.4; projections: 2006:-13.9, 2007:-15.5, 2008:-17.4, 2009:-8.3
- Capital and financial account (percent of GDP): 2001:-13.9, 2002:-10.9, 2003:-0.6, 2004:-17.3, 2005:-3.9; projections: 2006: 2.7, 2007: 6.9, 2008: 11.0, 2009: 20.0
  - Private sector capital (percent of GDP): 2001:-6.4, 2002:-3.3, 2003: 5.0, 2004:-10.8, 2005: 3.2; projections: 2006: 8.7, 2007: 13.8, 2008: 20.2, 2009: 24.9
    - Direct investment (percent of GDP): 2001:-0.2, 2002:-1.2, 2003:-3.0, 2004:-1.1, 2005:-0.4; projections: 2006: 0.5, 2007: 2.4, 2008: 4.5, 2009: 6.1
    - Portfolio investment (percent of GDP): 2001: 0.6, 2002: 2.0, 2003:-0.8, 2004:-0.8, 2005:-0.9; projections: 2006:-0.9, 2007:-0.9, 2008:-0.9, 2009:-1.0
    - Commercial banks (percent of GDP): 2001: 1.0, 2002: 2.2, 2003:10.3, 2004: 2.0, 2005: 6.0; projections: 2006: 6.5, 2007: 7.0, 2008: 8.5, 2009: 9.1
    - Corporations (percent of GDP): 2001: 0.4, 2002: 8.3, 2003:12.0, 2004:11.1, 2005:16.4; projections: 2006:17.6, 2007:18.8, 2008:20.1, 2009:21.5
    - Other private capital (percent of GDP): 2001:-8.2, 2002:-14.7, 2003:-13.4, 2004:-21.9, 2005:-17.9; projections: 2006:-14.9, 2007:-13.5, 2008:-11.9, 2009:-10.9
- Errors and omissions, net (percent of GDP): 2001:-10.2, 2002:-7.5, 2003:-5.2, 2004:-7.8, 2005:-7.8; projections: 2006:-7.8, 2007:-7.8, 2008:-7.8, 2009:-7.8
- Overall balance (percent of GDP): 2001: 9.3, 2002: 12.5, 2003: 30.1, 2004: 21.7, 2005: 19.8; projections: 2006: 13.2, 2007: 10.1, 2008: 9.1, 2009: 14.3
- Financing — net international reserves (percent of GDP): 2001:-10.7, 2002:-13.0, 2003:-31.2, 2004:-21.7, 2005:-19.8; projections: 2006:-13.2, 2007:-10.1, 2008:-9.1, 2009:-14.3
  - Gross reserves ( - increase, in billions of U.S. dollars): 2001:-8.8, 2002:-9.4, 2003:-29.1, 2004:-20.1, 2005:-18.5; projections: 2006:-12.1, 2007:-9.4, 2008:-8.8, 2009:-14.3
  - Net Fund liabilities (in billions of U.S. dollars): 2001:-3.8, 2002:-1.5, 2003:-2.0, 2004:-1.6, 2005:-1.2; projections: 2006:-1.1, 2007:-0.7, 2008:-0.3, 2009: 0.0
    - Purchases: 0.0 for all years shown
    - Repurchases: 2001:-3.8, 2002:-1.5, 2003:-2.0, 2004:-1.6, 2005:-1.2; projections: 2006:-1.1, 2007:-0.7, 2008:-0.3, 2009: 0.0
  - Other liabilities (in billions of U.S. dollars): 2001: 1.9, 2002:-2.1, 2003: 0.0, 2004: 0.0, 2005: 0.0; projections: 2006: 0.0, 2007: 0.0, 2008: 0.0, 2009: 0.0
- Memorandum items:
  - Current account (in percent of GDP): 10.9, 9.0, 8.3, 8.4, 4.8, 2.4, 1.3, 0.7, 0.2
  - Gross reserves 1/ (in billions of U.S. dollars): 34.5, 47.8, 76.9, 97.0, 115.5, 127.6, 137.0, 145.8, 160.1
  - Reserves (in months of imports of GNFS): 5.0, 5.6, 7.1, 7.6, 8.5, 8.9, 9.0, 8.7, 8.8
  - World oil price ($ per barrel) (WEO): 2001: 24.3, 2002: 25.0, 2003: 28.9, 2004: 34.5, 2005: 32.8; projections: 2006: 30.5, 2007: 29.5, 2008: 29.0, 2009: 28.0
  - Public external debt service (percent of exports of goods and services): 2001: 15.1, 2002: 9.3, 2003: 10.0, 2004: 5.8, 2005: 6.6; projections: 2006: 6.0, 2007: 6.1, 2008: 6.9, 2009: 4.5
  - Public external debt (percent of GDP): 2001: 11.8, 2002: 10.3, 2003: 9.3, 2004: 8.8, 2005: 7.7; projections: 2006: 6.1, 2007: 6.7, 2008: 6.0, 2009: 3.1
  - Private external debt (incl local gov't, in billions): 2001: 38.6, 2002: 49.1, 2003: 72.1, 2004: 86.1, 2005: 110.0; projections: 2006: 135.7, 2007: 163.2, 2008: 193.7, 2009: 226.2
  - Total external debt (in billions): 2001: 150.4, 2002: 149.7, 2003: 165.9, 2004: 173.8, 2005: 191.3; projections: 2006: 211.9, 2007: 233.9, 2008: 256.8, 2009: 286.4
  - Total external debt (percent of GDP): 2001: 49.1, 2002: 43.4, 2003: 38.2, 2004: 31.0, 2005: 29.1; projections: 2006: 28.3, 2007: 28.3, 2008: 28.5, 2009: 29.5

*Source: Central Bank of Russia; and Fund staff estimates.*

### External debt dynamics and stress-test assumptions (selected rows)
- External debt (percent of GDP) 1997–2009: 1997: 41.4, 1998: 60.1, 1999: 90.9, 2000: 60.9, 2001: 49.1, 2002: 43.4, 2003: 38.2, 2004: 31.0, 2005: 29.1, 2006: 28.3, 2007: 28.3, 2008: 28.5, 2009: 29.5
- Change in external debt (percent of GDP) 1997–2009: 1997: 6.6, 1998: 18.7, 1999: 30.8, 2000:-30.1, 2001:-11.8, 2002:-5.7, 2003:-5.0, 2004:-7.3, 2005:-1.9, 2006:-0.8, 2007: 0.0, 2008: 0.3, 2009: 0.9
- Identified external debt-creating flows (4+8+11): 1997:-1.1, 1998: 21.4, 1999: 10.6, 2000:-39.3, 2001:-20.1, 2002:-14.1, 2003:-16.3, 2004:-16.9, 2005:-9.3, 2006:-6.1, 2007:-4.3, 2008:-3.4, 2009:-3.0
- Current account deficit, excluding interest payments (percent of GDP): 1997:-2.4, 1998:-4.2, 1999:-17.1, 2000:-21.3, 2001:-13.7, 2002:-11.1, 2003:-10.1, 2004:-10.4, 2005:-6.7, 2006:-4.4, 2007:-3.3, 2008:-2.7, 2009:-2.3
- Exports (goods & services, percent of GDP): 1997: 25.0, 1998: 28.1, 1999: 43.4, 2000: 44.1, 2001: 36.7, 2002: 34.8, 2003: 35.1, 2004: 34.6, 2005: 30.7, 2006: 26.8, 2007: 24.7, 2008: 23.4, 2009: 22.3
- Imports (goods & services, percent of GDP): 1997: 22.7, 1998: 24.1, 1999: 27.2, 2000: 23.5, 2001: 23.8, 2002: 24.0, 2003: 23.7, 2004: 23.1, 2005: 23.2, 2006: 21.8, 2007: 20.9, 2008: 20.3, 2009: 20.7
- Automatic debt dynamics contribution (percent of GDP): 1997: 1.7, 1998: 26.1, 1999: 28.0, 2000:-18.2, 2001:-6.5, 2002:-3.3, 2003:-6.9, 2004:-6.6, 2005:-2.6, 2006:-1.6, 2007:-0.7, 2008:-0.2, 2009: 0.0
- Gross external financing need (in billions of U.S. dollars): 1997: 13.4, 1998: 19.7, 1999:-2.7, 2000:-25.2, 2001:-3.7, 2002:-0.8, 2003:-10.9, 2004:-14.1, 2005: 7.0, 2006: 21.1, 2007: 30.1, 2008: 40.4, 2009: 42.8
- Gross external financing need (percent of GDP): 1997: 3.3, 1998: 6.4, 1999:-1.4, 2000:-9.7, 2001:-1.2, 2002:-0.2, 2003:-2.5, 2004:-2.5, 2005: 1.1, 2006: 2.8, 2007: 3.6, 2008: 4.5, 2009: 4.4

### Key macroeconomic and external assumptions (selected)
- Real GDP growth (in percent) historical series and projections: 1997: 1.4, 1998:-5.3, 1999: 6.3, 2000: 10.0, 2001: 5.1, 2002: 4.7, 2003: 7.3, 2004: 7.3, 2005: 6.4, 2006: 5.5, 2007: 5.0, 2008: 5.0, 2009: 5.0
- GDP deflator in U.S. dollars (change in percent): 1997: 2.0, 1998:-29.3, 1999:-32.0, 2000: 20.5, 2001: 12.3, 2002: 7.7, 2003: 16.7, 2004: 20.6, 2005: 10.2, 2006: 8.0, 2007: 5.3, 2008: 3.6, 2009: 2.9
- Nominal external interest rate (in percent): 1997: 8.5, 1998: 9.1, 1999: 6.0, 2000: 6.1, 2001: 5.5, 2002: 5.0, 2003: 5.2, 2004: 7.0, 2005: 7.2, 2006: 7.6, 2007: 7.8, 2008: 7.9, 2009: 8.0
- Growth of exports (goods & services, U.S. dollar terms, percent): 1997:-1.9, 1998:-14.0, 1999:-2.5, 2000: 35.4, 2001:-1.7, 2002: 6.8, 2003: 26.3, 2004: 27.4, 2005: 4.1, 2006:-0.6, 2007: 1.7, 2008: 3.3, 2009: 2.7
- Growth of imports (goods & services, U.S. dollar terms, percent): 1997: 6.1, 1998:-19.1, 1999:-29.0, 2000: 15.5, 2001: 19.5, 2002: 13.8, 2003: 23.4, 2004: 26.3, 2005: 17.6, 2006: 7.1, 2007: 5.7, 2008: 5.8, 2009: 10.4

- Notes on scenario assumptions included in the source:
  - 1. Real GDP growth, nominal interest rate, dollar deflator, non-interest current account, and non-debt inflows are at historical average in 2004-2009.
  - 2. Nominal interest rate is at historical average plus two standard deviations in 2004 and 2005.
  - 3. Real GDP growth is at historical average minus two standard deviations in 2004 and 2005.
  - 4. Change in US dollar GDP deflator is at historical average minus two standard deviations in 2004 and 2005.
  - 5. Non-interest current account is at historical average minus two standard deviations in 2004 and 2005.
  - 6. Combination of 2-5 using one standard deviation shocks.

*Source: Central Bank of Russia; and Fund staff estimates.*

### 7. One time 30 percent nominal depreciation in 2004

### 7. One time 30 percent nominal depreciation in 2004

### Scenario description
- Scenario label: "One time 30 percent nominal depreciation in 2004" (listed as scenario 6 in the stress-test panel).
- Context: Presented within "Table 9. Russian Federation: Public Sector Debt Sustainability Framework" under "II. Stress Tests for Public Debt Ratio".
- Footnote on definition: "Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator)." (footnote 7/).

### Projected impact on public sector debt ratio (scenario 6)
- Series of projections (presumably across 2004-09 as in the stress-tests panel):
  - 34.3
  - 29.5
  - 26.5
  - 24.5
  - 22.6
  - 21.4

### Assumptions and related definitions cited in the table notes
- Debt dynamics formula reference: "Derived as [(r - π(1+g) - g + αε(1+r))/(1+g+π+gπ)] times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar)." (footnote 2/).
- Exchange-rate contribution to debt dynamics: "The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r)." (footnote 4/).
- Definition of gross financing need: "Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period." (footnote 5/).

### Comparative placement within stress tests (selected for context)
- Scenario numbering and brief outcomes (as presented in the same stress-tests block):
  - 1. Real GDP growth, real interest rate, and primary balance at historical averages in 2004-2009: 27.8, 28.2, 28.3, 28.4, 28.1, 28.2
  - 2. Real interest rate at historical average plus two standard deviations in 2004 and 2005: 25.9, 26.2, 23.4, 21.5, 19.6, 18.6
  - 3. Real GDP growth at historical average minus two standard deviations in 2004 and 2005: 24.5, 24.0, 20.4, 17.9, 15.7, 14.4
  - 4. Primary balance at historical average minus two standard deviations in 2004 and 2005: 34.4, 42.7, 39.0, 36.6, 34.3, 32.9
  - 5. Combination of 2-4 using one standard deviation shocks: 34.7, 42.3, 34.5, 28.3, 22.9, 18.4
  - 6. One time 30 percent real depreciation in 2004: 34.3, 29.5, 26.5, 24.5, 22.6, 21.4
  - 7. Fall in the oil prices to 15 US$ per barrel in 2005 and 2006 and to 20 US$ afterwards (with additional adjustments described in footnote 8/): 20.1, 34.2, 37.0, 37.4, 37.6, 38.5

### Notation on shock interpretation
- Footnote 7/ clarifies the distinction between nominal and real depreciation for the scenario: "Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator)."

*Source: _cr04314 - 7. One time 30 percent nominal depreciation in 2004*

### 1.      The current Country Assistance Strategy (CAS) was approved by the Bank’s Board in

### The current Country Assistance Strategy (CAS) was approved by the Bank’s Board in June 2002

### CAS objectives and overall emphasis
- Continued emphasis on Bank support to deepen structural reforms.
- CAS main needs: 
  - (1) improve the business environment in order to encourage new firm growth;
  - (2) strengthen public sector management (including civil service reform, intergovernmental finance reform and support of judicial reforms);
  - (3) safeguard against the social and environmental risks of transition.
- World Bank Group work in each of these three areas is described below.

### Improving the business environment and enhancing competition
- Removing administrative barriers to business activity, including monitoring administrative barriers to small business development and WTO accession advisory work.
- Restructuring priority sectors:
  - preparation underway for lending operations in areas such as the land cadastre and housing and communal services;
  - advisory work in areas such as electricity and gas sector restructuring, railways restructuring, and urban transport.
- Enhancing the protection of property rights, contract enforcement, and corporate governance, including enterprise support:
  - preparation of a judicial reform project;
  - IFC and IBRD work on corporate governance.
- Improving financial intermediation:
  - IFC investments and MIGA program;
  - preparation underway for an IBRD regional banks loan to focus on medium-size enterprises;
  - FSAP;
  - advisory work on bank supervision, deposit insurance, and housing finance.
- Strengthening Russia’s role in the global knowledge economy:
  - advisory work focusing on science and technology policy;
  - Global Knowledge Economy strategy for Russia;
  - reform of the telecommunication sector;
  - preparation of a science and technology lending project.

### Strengthening public sector management
- Strengthening and modernizing civil service, public administration and judicial systems:
  - multi-year advisory work, in partnership with DFID and other donors, focusing on civil service reform;
  - preparation of a judicial reform project.
- Improving public finance:
  - Regional Fiscal Federalism, Treasury Modernization, Tax Administration and Customs Modernization, and St. Petersburg Economic Development IBRD loans;
  - WBI work on intergovernmental fiscal relations and urban and city management capacity building;
  - public expenditure reviews;
  - advisory work on housing and communal service reform;
  - Country Financial Accountability Assessment (CFAA);
  - IDF grant on public expenditure management for the Ministry of Finance.

### Mitigating social and environmental risks
- Improving health status, services and finance:
  - TB/AIDS and Health Reform Implementation loans;
  - advisory services and capacity building in health policy, adult health, and health insurance.
- Improving relevance and delivery of modern educational services:
  - Education Reform and E-Learning loans;
  - advisory work on modernizing the education system.
- Mitigating income insecurity, vulnerability and minimizing the risk of poverty:
  - Northern Restructuring loan and preparation of a child welfare project;
  - multi-year capacity building program, in partnership with DFID, aimed at poverty monitoring and policy development;
  - advisory work on pension reform, child welfare and targeting of social assistance.
- Mitigating environmental risks and improving the environment:
  - Forestry loan and related advisory services;
  - preparation of loan to modernize meteorological forecasting;
  - Global Environment Facility (GEF) program;
  - advisory work on Environmental Management Systems.

### Bank analytical program and Programmatic Country Economic Memorandum (CEM)
- Analytical program components:
  - just-in-time demand driven policy notes;
  - multi-year technical assistance aimed at building capacity;
  - deeper analytical studies.
- Programmatic CEM approach:
  - addresses a different theme every year in line with CAS priority areas rather than a single comprehensive report.
- Draft of the first CEM (recently issued) assesses the extent of structural change in the Russian Federation and its contribution to long-term growth.
- Five connected dimensions of structural change analyzed in the CEM:
  - Spatial reallocation caused by the legacy of industrialization and urbanization under central planning;
  - Reallocation of employment across the economy’s main sectors;
  - Productivity changes originating from shifts of employment across sectors and from restructuring within sectors;
  - Restructuring in the industrial sector;
  - Concentration of ownership and its implication for industrial restructuring and economic performance.

### Poverty assessment findings and recommended strategy
- The recently completed Poverty assessment develops comparable survey data to estimate trends in poverty and inequality in the Russian Federation.
- The report documents the success in reducing poverty since 1999 and highlights the challenges facing the country in reducing poverty by half by 2007.
- The report stresses the need for a three-pronged strategy:
  - a. promoting broad-based and diversified growth to reduce poverty;
  - b. targeting interventions to fight the deep pockets of poverty among children, rural areas and depressed regions;
  - c. improving the targeting effectiveness of social programs.

### Government priorities and future World Bank Group operations
- President Putin signaled intention to shift focus from macroeconomic stability and growth to sustaining high levels of growth and reducing poverty and regional disparity.
- Government reaffirmed interest in continuing a strategic partnership with the World Bank Group encompassing policy advice and technical assistance, sovereign lending, joint public and private financing, and guarantees.
- Given recent budget surpluses and growing reserves, the government intends to strictly limit foreign borrowing for non-interest budget expenditures and seeks to selectively use the IBRD’s project design, preparation and monitoring capacity while limiting loan amounts and maintaining flexibility.
- IBRD and government jointly agreed to future sovereign borrowing in three areas:
  - public infrastructure projects of national importance;
  - institutional strengthening of public administration;
  - social infrastructure.
- Priority considerations for future lending program:
  - increase the amount of government co-financing;
  - develop new lending instruments and mechanisms to tailor resource flows to the budgetary situation over an extended period of time.

### Statistical issues — summary of key points
- General:
  - Russia has a reasonably comprehensive and timely statistical database, but difficulties remain in terms of data accuracy.
  - Authorities are generally cooperative in reporting data to the Fund; data are provided on a timely basis with a few exceptions.
- Data dissemination and SDDS:
  - A draft ROSC module on data dissemination practices was prepared in 1999–2000 (never published); a new ROSC data module was prepared in October 2003 and the authorities approved publication on the IMF website on April 25, 2004.
  - Recent improvements moved Russia closer to subscription to the SDDS. The Ministry of Finance contacted STA on April 28, 2004 to reiterate Russia's commitment to subscribe to the SDDS. Russia has not yet nominated a National SDDS Coordinator and STA is awaiting an official letter from the authorities.
- National accounts:
  - Goskomstat compiles quarterly and annual national accounts using the 1993 System of National Accounts.
  - Source data: surveys of businesses and households, supplemented by administrative data; sample surveys increasingly replace full-count collections.
  - Coverage improvements needed for small and medium enterprises.
  - Statistical discrepancy between production and expenditure approaches generally no more than 2 percent.
  - Estimates of the financial account by institutional sector are not compiled.
  - Delay in finalizing a modern statistics law (requiring firms to provide data with realistic penalties and confidentiality guarantees) impedes further improvement.
  - Authorities do not publish separate data on export and import volumes; revisions are not flagged when disseminated.
- Prices:
  - Goskomstat compiles a national CPI developed with Fund technical assistance.
  - Since January 2003 Goskomstat stopped weekly publication of headline inflation and continued monthly reports; started publication of monthly core inflation data.
  - Further improvements possible with a new household budget survey and better treatment of seasonal items.
  - Since November 2003 monthly CPI and PPI presented in two formats: (i) index using annual average prices for 1995 as reference (1995=100) and (ii) percentage of a previous month. Basic component time series and component weights not readily available.
- Government finance statistics:
  - Staff receives monthly information on revenues, expenditures, and financing of federal and local governments and quarterly information on extrabudgetary funds.
  - Published functional classification of expenditure differs slightly from international standards; expenditure data by economic type need improvement and are compiled with a long delay (publication lag of one year).
  - Data on domestic and external federal debt are compiled monthly but made public only in summary form annually; no unified debt monitoring and reporting system.
  - Ongoing improvements in coverage and quality of GFS data; expenditure data remain poor.
  - Reform of budgetary accounting well advanced; latest data provided for publication in the GFS Yearbook for 2002 were reported on an accrual basis in accordance with Manual on Government Finance Statistics 2001. Treasury reports aggregate government finance data for publication in IFS on a cash basis since April 1996.
- Monetary statistics:
  - Monetary data are reasonably comprehensive and generally in accordance with international standards.
  - 2003 data ROSC identified issues: exclusion of financial institutions issuing deposit substitutes, treatment of securities repurchase operations with nonresidents, exclusion of financial derivatives from instrument classification, valuation of monetary gold and securities not at market prices, and accrued interest not included in underlying instruments.
  - Authorities included all unoperational credit institutions in coverage and reclassified their deposits as restricted deposits following the data ROSC.
  - CBR intends further compilation procedure revisions to conform fully with the Monetary and Financial Statistics Manual 2000.
  - Analytical accounts for monetary authorities and commercial banks are reported for publication in IFS with a lag of one month; timely interest rate data available.
- External sector statistics:
  - Balance of payments compiled on the basis of the Fund’s Balance of Payments Manual (Fifth Edition); significant progress made with Fund cooperation.
  - Scope to improve coverage of certain current and capital and financial account components and the detail available to the public, especially on the financial account.
  - State Customs Committee needs to substantially improve coverage and valuation of exports and imports. Merchandise imports data are subject to large adjustments for under recording (including “shuttle trade”, smuggling, under-valuation).
  - Persistent differences between partner country and customs data on imports remain; agencies seek reconciliation.
  - CBR developed a methodology for calculating components of export and import transactions unrecorded by customs authorities.
  - Goskomstat needs to improve coverage and quality of surveys on direct investment and trade in services including travel; CBR has moved toward direct data collection to address limitations.
  - Russia has begun disseminating the data template on international reserves and foreign currency liquidity; published historic series on reserves have not been corrected for changes in definitions.
  - Headline reserves data reported to the Fund and markets weekly with a four-business day lag; Fund receives additional reserve detail through the central bank balance sheet but not as comprehensive as the reserve template.
  - Quarterly external debt data are now published by sector, maturity, instrument, and currency, with a lag of one quarter as prescribed by the SDDS, but gaps remain (notably lack of a debt service schedule and gross payments information).
  - CBR commenced publishing an annual international investment position for all sectors with data starting in 2001; international investment position for the banking sector is now available on a quarterly basis.
- SDDS-related progress:
  - Goskomstat, the MOF, and the CBR follow the SDDS metadata framework and Russia’s data dissemination practices meet most SDDS requirements.
  - During the ROSC mission, authorities disseminated international reserves data using the Fund’s Data Template on International Reserves and Foreign Currency Liquidity.
  - After the ROSC mission, Goskomstat published price statistics in index format (1995=100) on its website, and the CBR disseminated analytical accounts of the monetary authorities with SDDS-prescribed timeliness beginning with data for the reference period of October 2003.

### Core statistical indicators (as presented)
- Table heading: Russian Federation: Core Statistical Indicators (As of July 22, 2004)
- Date of Latest Observation entries shown in the table header include: 7/12/04, 7/1/04, 7/1/04, 7/1/04, 6/1/04, 6/30/04, 6/04, 5/04, 6/04, 5/30/04, Q1/04, 6/04.
- Date Received entries shown include: 7/12/04, 7/7/04, 7/7/04, 7/7/04, 7/7/04, 7/15/04, 7/6/04, 7/9/04, 7/9/04, 6/10/04, 5/21/04, 7/9/04.
- Frequency codes and explanations (as used in table): D-daily, W-weekly, M-monthly, Q-quarterly. Source codes: MAR-Market, F-Ministry of Finance, C-CBR, GKS-Goskomstat. Mode of reporting codes: E-electronic, V-variable, F-cable/fax. Confidentiality: U-unrestricted, C-for use by Fund staff and the Executive Board.

*INTERNATIONAL MONETARY FUND — RUSSIAN FEDERATION: Staff Report for the 2004 Article IV Consultation — Supplementary Information (Prepared by European Department; Approved by Michael Deppler and Carlos Muñiz; August 30, 2004).*

### 1.      This supplement contains information on recent economic developments in Russia

### _cr04314 - 1.      This supplement contains information on recent economic developments in Russia

### Oil prices, macro outlook, and fiscal implications
- WEO oil price projections raised to $37 a barrel in 2004 and 2005.
- Balance of payments and fiscal outlook strengthened; limited broader macroeconomic implications expected.
- Current account surplus in 2004 likely higher than previously expected, by perhaps 1½ percent of GDP.
- Higher current account surpluses (by 2–3 percent of GDP a year) are expected to translate into an accelerated increase in foreign reserves provided the authorities:
  - move forcefully to strengthen the banking system; and
  - prove even-handed and transparent in enforcing tax legislation and the rule of law more generally.
- Higher oil revenues in 2004 will be fully saved in the oil stabilization fund.
- Draft 2005 budget (submitted August 26) assumes revenues about ⅔ percentage points of GDP higher than projected at the time of the mission, reflecting mainly higher oil prices and payment of back-taxes by Yukos.
  - Half of these additional revenues have been reflected in higher spending.
  - The 2005 budget deficit on a constant oil price basis will be about ⅓ percent of GDP higher than previously projected, raising the total fiscal stimulus to 1⅓–1½ percent of GDP next year.
- Oil stabilization fund cap: savings are supposed to cease once the cap of Rub 500 billion is reached — under the revised oil price assumption this could happen late this year — but statements by the president and the minister of finance suggest any revenues arising from Urals oil prices above the revised budgetary assumption of $28 per barrel will be saved.
- Staff raised its forecast for GDP growth in 2005 by only ¼ percentage point despite oil export earnings being revised up by 1½ percent of GDP, reflecting the likelihood that much of the windfall will be saved (about 80 percent of higher oil sector earnings are taxed at the current level of oil prices).
- Headline inflation rose slightly in July, to 10.4 percent; ruble remained broadly stable against the dollar.
- Authorities narrowed the target range for end-year inflation in 2005 to its upper half, from 6½–8½ percent to 7½–8½ percent.
- Staff view: fully saving oil revenues over and above what is assumed in the budget is key to managing macroeconomic challenges associated with very high oil prices.

### Balance of payments, reserves, external position
- External current account surplus has remained at 8-9 percent of GDP during the past two years.
- Net private capital outflows declined substantially in 2003 but increased in the first half of 2004, with volatility linked to the Yukos affair, prospects for global interest rates, and perceived changes in the central bank’s intervention and exchange rate strategy.
- Gross international reserves stood at about $88.5 billion (over seven months of imports) at end-July.
- Public external debt, net of reserves, has fallen close to zero, compared with $140 billion in 1998.
- Central Bank of Russia interventions to slow ruble appreciation were largely unsterilized, causing a surge in money growth during 2003 and broad money growth; credit to the economy grew around 44 percent in the year to June 2004.

### Fiscal stance and budgetary developments
- General government overall balance (commitment basis):
  - 2001: 2.7 percent of GDP
  - 2002: 0.6 percent of GDP
  - 2003: 1.1 percent of GDP
  - 2004: 3.1 percent of GDP (estimate)
- Underlying fiscal loosening at constant oil prices of about 1 percent of GDP in 2003, despite higher oil prices and strong growth.
- 2004 budget envisages moderate tightening via postponement of non-interest expenditure increases; 2005 plans suggest reversal toward relaxation, increasing pressure to spend oil revenue windfalls on tax cuts and expenditure reforms.
- Directors recommended increasing the cap on the collection of windfall oil revenues in the oil stabilization fund and considering use of some revenues to reduce debt.
- Directors cautioned that fiscal policy should not provide additional stimulus at this point in the economic cycle; they viewed the draft 2005 budget’s larger stimulus as exacerbating pressures for real ruble appreciation and inflationary pressures.
- Directors noted that once cyclical pressures eased, there could be a case for spending more on carefully elaborated long-term fiscal structural reforms (including health care and pension reform, and public infrastructure).

### Banking sector, supervision, and crisis management
- Situation in the banking sector remained calm during August; banks’ balance sheet data for July not yet available.
- Amendments strengthening the bank bankruptcy law were approved by the Duma end-July, by the Federation Council on August 8, and signed into law by the president on August 20.
- Increased regulatory vigilance triggered nervousness in the private banking sector earlier in the year.
  - CBR withdrew the license of a bank in May 2004 for AML/CFT violations, leading to a liquidity squeeze and deposit runs at some banks; situation calmed after prompt CBR action.
- Directors stressed urgency of strengthening prudential supervision and crisis management tools, while pressing ahead with closing unsound banks.
- Directors commended CBR’s actions to calm the situation, including halving reserve requirements and extending interim household deposit insurance to all banks, but noted extension of deposit insurance could increase moral hazard.
- Directors urged authorities to give the central bank strong political support and facilitate development of more effective instruments for banking supervision and weeding out problem banks.
- Directors welcomed prompt Duma action to strengthen the bank bankruptcy law and encouraged further development of a private banking sector and stronger action to counter money laundering.

### Structural reform, governance, and rule of law
- Progress on structural reform has been limited; two major 2003 reforms related to the financial system:
  - Law on foreign exchange regulation introduced a far-reaching liberalization of capital flows and allows imposition of unremunerated deposit requirements on capital flows; CBR decided to introduce such requirements from August 2004.
  - Legislation introduced mandatory insurance of household deposits.
- Directors urged not to view high oil prices and strong growth as grounds for complacency; they saw this as an opportunity to carry out structural reforms to sustain medium-term growth.
- Policy priorities emphasized by Directors:
  - Diversify the economy and reduce reliance on natural resources.
  - Encourage domestic and foreign direct investment and improve the investment climate for small- and medium-sized enterprises.
  - Public administration reform, banking reform, housing reform.
  - Liberalize trade and pursue early WTO accession.
  - Improve governance and the rule of law, and resolve the Yukos affair.
  - Reform the energy sector, break up inefficient monopolies, and improve labor market flexibility.
- Directors welcomed findings of Reports on the Observance of Standards and Codes modules on data and fiscal transparency, and the authorities’ decision to publish these reports.
- Russia’s statistical database judged mostly adequate for surveillance; dissemination practices meet most SDDS requirements; authorities intend to subscribe to the SDDS.
- Progress commended in strengthening fiscal transparency and financial management.

### Paris Club debt and debt management
- Finance Minister Kudrin indicated Russia would like to replace its Paris Club debts with marketable securities.
- Issue likely to be discussed by Paris Club creditors once Russian authorities make specific proposals; staff will assess further once specifics are known.

### Executive Board assessment and policy recommendations
- Directors commended authorities’ macroeconomic management, strengthening GDP growth and the balance of payments.
- With a buoyant economy, Directors advised:
  - No fiscal stimulus at this point in the economic cycle.
  - Monetary policy should focus more on controlling inflation than on resisting nominal appreciation.
  - Central bank should clarify competing objectives of controlling inflation and managing the exchange rate; allow more nominal exchange rate flexibility.
  - Strengthen central bank independence.
- On capital account measures:
  - Most Directors saw unremunerated deposit requirements as, at best, temporary measures to stem capital inflows; deposit requirements should be temporary and reserved for exceptionally large and volatile inflows.
- On banking sector: strengthen prudential supervision, crisis management, and enforcement of sound prudential standards; continue closing unsound banks.
- Structural reform acceleration urged to sustain medium-term growth and diversify the economy.

### Selected economic indicators (as presented)
- Real GDP (annual percent change): 2001: 5.1; 2002: 4.7; 2003: 7.3; 2004: 7.3 (Est./Proj. as shown).
- Consumer prices:
  - Annual average: 2001: 21.5; 2002: 15.8; 2003: 13.7; 2004: 10.3.
  - End of period: 2001: 18.6; 2002: 15.1; 2003: 12.0; 2004: 10.0.
- GDP deflator (annual percent change): 2001: 16.5; 2002: 15.7; 2003: 14.2; 2004: 12.9.
- Public sector (in percent of GDP, commitment basis):
  - General government overall balance: 2001: 2.7; 2002: 0.6; 2003: 1.1; 2004: 3.1.
  - Revenue: 2001: 37.3; 2002: 37.6; 2003: 36.6; 2004: 37.0.
  - Expenditure: 2001: 34.6; 2002: 37.0; 2003: 35.5; 2004: 33.9.
    - Interest: 2001: 2.7; 2002: 2.1; 2003: 1.7; 2004: 1.3.
    - Non-interest: 2001: 31.9; 2002: 34.9; 2003: 33.8; 2004: 32.6.
  - Primary balance: 2001: 5.4; 2002: 2.7; 2003: 2.7; 2004: 4.4.
  - Federal government overall balance: 2001: 2.7; 2002: 1.3; 2003: 1.5; 2004: 3.0.
- External sector (in billions of U.S. dollars):
  - Total exports: 2001: 102; 2002: 107; 2003: 136; 2004: 174.
  - Total imports: 2001: 54; 2002: 61; 2003: 75; 2004: 96.
  - External current account (deficit -): 2001: 33; 2002: 31; 2003: 36; 2004: 47.
  - Stock of public external debt: 2001: 112; 2002: 103; 2003: 94; 2004: 88.
  - Gross reserves coverage (in months of imports of GNFS): 2001: 5.0; 2002: 5.6; 2003: 7.1; 2004: 7.6.
- Memorandum items:
  - Nominal GDP (in billions of rubles): 2001: 8,944; 2002: 10,834; 2003: 13,285; 2004: 16,090.
  - Exchange rate (rubles per U.S. dollar, period average): 2001: 29.2; 2002: 31.3; 2003: 30.7; 2004: ...
  - Russian oil price (U.S. dollars per barrel, c.i.f.): 2001: 22.9; 2002: 23.6; 2003: 27.3; 2004: 30.1.

*Source: IMF staff supplement and Public Information Notice summarizing the 2004 Article IV consultation with the Russian Federation.*

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