## _cr09246 ## Source details **Canonical URL:** [_cr09246](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09246.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09246.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09246.pdf.json) --- ### Macroeconomic contraction and output - Real GDP contracted by 9¾ percent in Q1 2009 (year-over-year). - Drivers and transmission: - Prior boom drivers reversed: rapidly rising oil prices and massive capital inflows. - Fixed investment plummeted, triggering an abrupt contraction in domestic demand and a steep drop in imports. - Inventories: a sharp drawdown of inventories accounted for 8½ percentage points of the total GDP decline of 9¾ percent (y/y) in Q1 2009. - Near-term outlook: - Staff projection: Real GDP is expected to contract by 6½ percent in 2009. - Growth projected to recover slowly over 2010; 2010 projection: 1.5 percent. ### Prices, labor market, and wages - Inflation: - CPI inflation peaked at 15.2 percent (y/y) in June 2008 and fell to 11.9 percent in June 2009. - Headline inflation expected to decline slowly, "falling to 11 percent by year-end" 2009; 2010 projected end-of-period inflation: 9.0 percent. - Labor market and wages: - Unemployment rate rose to 9.9 percent in May (seasonally adjusted). - Labor productivity (real GDP per unit employment) turned negative since early 2009, exerting downward pressure on real wages. - Unit labor cost growth is slowing rapidly after real wages had been growing well above productivity on average for almost a decade. ### External sector, exchange rate, and reserves - Exchange rate movements and assessment: - Since the onset of the crisis in September, the ruble has depreciated by around 15 percent against the U.S. dollar-euro basket. - Earlier pattern: first depreciated by about 30 percent over December-January, then recovered; after appreciation it remained 5 percent more depreciated than its pre-crisis level. - Staff analysis: the ruble remains broadly in equilibrium; projected medium-term oil prices imply a parallel appreciation of the equilibrium real effective exchange rate. - Reserves and flows: - Gross international reserves: peaked at $598 billion in August 2008 → trough of $375 billion in March 2009 → ticked up to over $400 billion by end-June 2009. - Capital outflows reached $131 billion in Q4 2008. - Current account: largely stabilized at around $8 billion; staff projections: Current account (percent of GDP) 2009: 1.5; 2010: 2.9. - Projected overall balance-of-payments deficit of "about $50 billion in 2009"; reserves would decline to "some $375 billion by end-year." - External indicators (selected): - Exports (total merchandise, f.o.b.): 2008: 471.6; 2009: 278.4; 2010 (Proj.): 320.8 (Billions of U.S. dollars). - Gross international reserves (billions of U.S. dollars): 2008: 427.1; 2009: 375.7; 2010 (Proj.): 397.2. ### Credit, banking sector strains, and financial stability - Credit dynamics and asset quality: - Overdue loans more than doubled since January, reaching 4.6 percent of total loans in May 2009 despite regulatory forbearance and anecdotal evergreening. - Controlling for depreciation’s impact on ruble value of FX loans, credit fell by 1 percent over Q1 2009. - Nominal credit projected to remain relatively flat for the rest of 2009, implying "a drop of some 10 percent in real terms." - Banking behavior and policy response: - Banks displayed a strong preference for liquidity; drew down foreign assets to reduce foreign liabilities. - CBR introduced regulatory forbearance: easing loan classification and provisioning requirements; loosened accounting standards; expanded access to unsecured loan auctions. - Some small- and medium-sized banks taken into receivership; CBR liquidity measures and forbearance helped weather early crisis stages. - Financial support measures (selected amounts, Announced; Actual use as of June 12, 2009; Gross Treasury financing need): - Deposit insurance: 200; 200; 200. - Purchase of assets (Mortgages financed from the National Welfare Fund): 200; 0; 0. - Capital injection by MOF: 505; 205; 505. - Central bank lending: 1,309; 1,309; 0. - Bank loan/recapitalization: 1,787; 839; 0. - Liquidity support from MOF: 300; 155; 0. - Total: 4,301; 2,708; 705. - CBR crisis liquidity: - New uncollateralized lending facility on top of Rub 200 billion rolled over via daily repos; as of June 12, Rub 720 billion in uncollateralized lending; other loans (nontraded collaterals) amounted to Rub 589 billion. ### Monetary policy phases, rates, and liquidity operations - Three phases identified: accommodation; devaluation and tightening; gradual easing. - Accommodation: - Large liquidity provision via government auctions of excess budgetary funds; CBR uncollateralized loans and guarantees; raised deposit-insurance limit. - By mid-January pace of reserve loss exceeded $50 billion per month; total reserve loss since August amounted to over $200 billion. - Devaluation and tightening: - End-January: one-off 10-percent weakening of the effective exchange-rate band; CBR defended the ruble at the weak bound. - Interest rates rose—overnight interbank rates reached 28 percent at their peak. - Repo interest rates increased by almost 300 bps in February to around 12 percent; rates on unsecured loans rose by almost 500 bps to around 18 percent. - Tightening eased pressure and reserves leveled off at around $380 billion. - Gradual easing: - Repo rates fell to 8¾ percent by late June; renewed inflows improved local liquidity and interbank lending; CBR uncollateralized loans being repaid ahead of schedule. - Despite easing, banks preferred holding deposits at the CBR rather than extending credit. ### Fiscal policy, stimulus, and near-term outlook - Fiscal developments and supplementary budget: - "Some 38 percent of expenditures were executed in the fourth quarter" (backloaded expenditures). - April 2009 supplementary budget: total expenditure expected to increase by some 5 percent of GDP; large discretionary increases in defense and security; anti-crisis tax reductions, support to strategic sectors, enhanced social assistance. - Excluding budgetary support to the financial sector, Russia’s announced discretionary fiscal stimulus is described as "one of the highest in the G-20." - Fiscal projections and key indicators: - Staff projection: General government overall balance (percent of GDP) 2008: 4.3; 2009: -5.5; 2010: -5.0. - Headline balance expected to swing from "a surplus of 4¼ percent of GDP in 2008" to "a deficit of about 5½ percent in 2009" — "a turnaround of nearly 10 percent of GDP." - Oil revenues projected to fall by "about 4¼ percent of GDP." - Expenditures set to rise by "over 5 percent of GDP in the second half of the year." - Non-oil deficit of the general government projected to increase by "5½ percent of GDP — reaching 13¾ percent of GDP." - Planned financing: deficit monetized by drawing down the oil Reserve Fund, except for domestic borrowing "of up to 1 percent of GDP." - Near-term macro projections (selected): - Real GDP (percent change): 2008: 5.6; 2009: -6.5; 2010: 1.5. - Inflation (e.o.p., percent change): 2008: 13.3; 2009: 11.0; 2010: 9.0. - World oil price (U.S. dollars per barrel): 2008: 97.0; 2009: 60.5; 2010: 74.5. - Net capital inflows (billions of U.S. dollars): 2008: -133.0; 2009: -67.9; 2010: -25.8. - With planned monetization, capital outflows expected to remain relatively high at "$68 billion." ### Fiscal policy assessment and recommendations - Concerns: - Fiscal policy had become increasingly pro-cyclical prior to the crisis. - The planned fiscal relaxation is judged excessive: taking into account pension reform financing, the relaxation will increase the non-oil deficit by some 11–13 percent of GDP above the government’s medium-term framework. - To reach the authorities’ "4.7 percent of GDP medium-term target" for the non-oil deficit would require "an adjustment in expenditure or non-oil revenues of some 9 percent of GDP over the next four years"; accounting for pension reform and banking support, "the required adjustment could exceed 11 percent of GDP." - Staff’s recommended approach: - Keep the change in the non-oil deficit to "2–3 percent of GDP in 2009" and improve composition. - Reorient stimulus toward better-targeted and self-reversing measures to achieve similar impact with a smaller fiscal cost, including: - Reduce support to strategic enterprises and streamline non-essential defense outlays. - Reorient toward temporary increases in social transfers targeted on credit-constrained households. - Frontload infrastructure projects for which preparations are advanced, alongside strengthening procurement procedures. - Frontloading pension reform is appropriate if additional outlays are offset by reductions in less efficient spending. - If a smaller non-oil deficit is targeted in 2009, scope may exist to maintain stimulus in 2010 if needed; if growth outlook improves, some withdrawal of stimulus "of around 1 percent of GDP" would be appropriate in 2010. ### Banking-sector policies and supervisory recommendations - Identified supervisory weaknesses: - Lack of comprehensive consolidated supervisory powers. - Generous accounting and provisioning rules limiting accurate gauging of asset quality and loan-loss reserves. - Shortcomings in reporting consolidated financial statements and monitoring off-balance-sheet activities. - Lack of adequate powers to monitor and supervise bank holding companies and sanction bank officers and directors. - Staff recommendations: - Undertake detailed reviews and mandatory systemic stress tests for large- and medium-sized banks using similar assumptions and the same point-in-time balance sheets to estimate viability and capital needs. - Develop regulatory guidance mapping supervisory actions as banks’ capital deteriorates to enable early planning by banks. - Develop contingency plans and resolution strategies; DIA to prepare for orderly disposition of assets from liquidated banks or DIA-assisted mergers and possible rise in deposit payouts. - Develop a communication strategy for rolling back regulatory forbearance and procedures for determining compliance with capital requirements after rollback. - Continue participation in international fora (e.g., Basel Committee) to improve coordination on regulation, resolution, and information sharing. - Authorities’ stance: - CBR agreed system is deteriorating but regarded problems as manageable within existing frameworks; no perceived need for systemic stress tests though ad-hoc stress testing is conducted. - Draft legislation to expand CBR’s consolidated supervision authority is under review and expected to be presented to Duma later this year. - Recapitalization plan (recent update): - Issue government securities (OFZ) equivalent to Rub 150 billion in 2009 and Rub 310 billion in 2010; OFZs exchanged with banks in return for preferred shares counting as Tier 1 capital. - DIA: 18 banks under rehabilitation; DIA has undisbursed funds from an initial Rub 200 billion allocation. ### Public-sector reforms and medium/long-term fiscal anchor - Public-sector reform priorities: - Reinvigorate reforms in health and education, civil service, military, and public administration to create fiscal space and improve expenditure efficiency. - Support for gradual replacement of revenue-based oil taxation regime with a profit-based system; precondition: transfer-pricing legislation aligned with OECD guidelines and strengthened enforcement capacity. - Anchoring long-term fiscal policy — Permanent Oil Income Model (POIM) recommendation: - POIM is recommended as a conservative benchmark to stabilize government consumption out of oil and financial wealth; objective: preserve government wealth and set a sustainable non-oil primary deficit. - Staff calculations/parameters: - POIM implies gradual adjustment in general government primary non-oil deficit of about 1.9 percent of GDP per year until 2015. - Under baseline projections, framework implies sustainable long-term level of non-oil primary deficit of 1½ percent of GDP (reported elsewhere as about 1.6 percent in baseline POIM results). - Sensitivity: - Long-term real Urals oil price scenarios: US$40 per barrel → sustainable non-oil deficit of 1.1 percent of GDP; US$100 per barrel → sustainable non-oil deficit of 1.9 percent of GDP. - Policy use: - POIM intended as an indicative benchmark; level should be periodically re-assessed and subjected to sensitivity analysis. ### Annex — Russia’s external stability and competitiveness (CGER analysis) - CGER findings: - Two most-recent CGER exercises found Russia’s real exchange rate (RER) broadly in equilibrium (Fall 2008; Spring 2009). - Spring 2009: REER depreciated by around 12 percent; projected long-term oil prices under the WEO dropped by around 30 percent between CGER exercises (about $100 to $73 per barrel), implying a 12–15 percent fall of Russia’s ERER given an elasticity of 0.4–0.5. - Staff modifications to CGER methodology for oil exporters: alternative underlying current-account estimate for Russia of 3.9 percent of GDP (after stripping temporary factors from 2008 recorded balance of 6.1 percent of GDP). - Alternative approaches and conclusions: - MB and ES approach variants, wage-based ERER regressions, and annuity-based wealth variants yield results broadly consistent with RER being roughly in equilibrium, though estimates are sensitive to benchmark choices. - Equilibrium dollar-wage calculations (1994–2008) indicate USD wages in Russia were near equilibrium after 2008 real depreciation (e.g., 2008 actual wage: 538; equilibrium wage: 547; equilibrium ratio: 98 percent). ### Oil taxation (Annex III) — analysis and policy implications - Fiscal context: - Total revenue from upstream oil activity was 9.5 percent of GDP in 2008. - Revenue composition (Percent of 2008 total): Mineral extraction tax (40%); Export duty (43%); Corporate income tax (17%). - Government receives 90 percent of each additional dollar of export earnings when Urals oil price exceeds $25 per barrel for a field with oil depletion below 80 percent. - Model simulations and findings: - Regimes compared: Current Russian (revenue-based) regime; Russia 2007; Russia Alternative (profit-based); international comparators. - Results: - Low-cost project: current regime yields high AETR but similar to Russia Alternative. - High-cost project: current regime AETR substantially higher—above all other countries in sample; Russia Alternative keeps AETR relatively unchanged by relying on profit-based instruments. - Very high-cost project: not economical under WEO oil prices for any regime (AETR exceeds 100 percent). - Investor implications: - Hurdle price for 12 percent after-tax return increases with project costs; Russia Alternative yields lower hurdle price, especially for very-high-cost projects. - Maximum viable operating cost at 12 percent after-tax return: under current regime fields with operating costs above $1.80 per barrel are not viable for the high-cost project; under alternative regime this maximum rises to $15 per barrel. - Policy recommendations and transition: - Move toward profit-based regime to maintain/increase government take for highly profitable projects and expand viable fields by reducing tax burden on marginal projects. - Preconditions: tighten transfer pricing rules, align with OECD guidelines, strengthen administrative capacity. - Transition safeguards: apply new regime to new fields only; enforce strict ring-fencing rules; consider intermediate measures (lower tax rates for frontier fields; make some costs deductible). ### World Bank Group activities and regional engagement (FY10–12 CPS planning) - CPS objectives and instruments: - Four primary CPS objectives: (a) diversifying the economy for sustainable development and growth; (b) improving public sector management and performance; (c) improving delivery of social services; (d) enhancing Russia’s global role. - Increased use of fee-based services, reimbursable technical assistance, guarantees for infrastructure financing, and regional focus on 6–10 selected regions. - Major program areas (selected): - Macroeconomic policy, fiscal sustainability, and management of external inflows; TA for Treasury and reserve/stabilization fund management. - Investment climate monitoring (BEEPS), regional diagnostics, energy efficiency programs, PPP support, sub-national lending and technical support. - IFC priorities: finance projects with spill-over effects; build relationships with medium-sized regional banks; mortgage financing, consumer finance, leasing; long-term senior and subordinated loans to strengthen bank balance sheets. - Social sector: sub-national focus on poverty monitoring, health strategy, education and vocational training, municipal services (heating, water, wastewater), and targeted regional projects. - Global role: assistance in ODA strategy, capacity building for aid management, participation in climate change and biodiversity initiatives, support for Russia’s donor engagements. ### Statistical issues and data adequacy (ANNEX III) - Data adequacy: - Data broadly adequate for surveillance but shortcomings in government finance statistics, external debt statistics, and data accuracy. - National accounts: inadequate firm reporting and lack of balance-sheet data; Rosstat follows 1993 SNA with needed methodological improvements (e.g., imputed rent, FISIM). - Prices: CPI/PPI coverage broad; CPI component weights available since 2006; PPI components not disclosed. - Government finance statistics: timeliness and quality could be improved; no unified debt monitoring and reporting system. - Monetary statistics and BOP: improvements made; need more detailed financial-account breakdowns to analyze complex flows. - Reporting and timeliness (selected): - Exchange Rates: latest observation 5/12/2009; frequency D. - International Reserve Assets: latest observation 5/1/09; frequency W. - Broad Money: latest observation March 2009; date received 4/28/09; frequency M. - External Current Account Balance: latest observation Q1 2009; date received 4/3/2009; frequency Q. - GDP/GNP: latest observation Q4 2008; date received 4/2/2009; frequency Q. ### Executive Board and staff appraisal (selected conclusions and recommendations) - Assessment: - Russia hit by dual shocks: collapse in oil prices and sudden reversal of capital flows; large and rapid output swing relative to G-20 peers. - Strengths: prior fiscal prudence left room for countercyclical fiscal expansion and reserve buffer. - Weaknesses: regulatory shortcomings, exchange-rate policies that encouraged FX borrowing and credit explosion, and stalled structural reforms affecting investment climate and diversification. - Directors’ recommendations: - Mandatory, bottom-up stress tests for larger banks; roadmap of supervisory responses; strengthen CBR supervisory authority. - Scale back fiscal stimulus and reorient composition toward self-reversing measures to avoid entrenchment and competitiveness losses. - Continue cautious monetary easing, consider transition toward inflation targeting over time, and allow greater exchange-rate flexibility while being prepared to intervene temporarily to preserve external stability. - Reinvigorate structural reforms in health and education and resume momentum on reforms critical to the investment climate and WTO accession. *Italic: IMF staff report excerpt — _cr09246.* ### 1. Credit Indicators, 2006–09......................................................................................... ### _cr09246 - 1. Credit Indicators, 2006–09 ### Macroeconomic contraction and output - Real GDP contracted by 9¾ percent in Q1 2009 (year-over-year). - Prior boom drivers that reversed: rapidly rising oil prices and massive capital inflows; fixed investment plummeted, triggering abrupt contraction in domestic demand. - Falling domestic demand led to a steep drop in imports. - Output and demand developments shown by contributions to GDP growth: consumption, gross fixed capital formation, net exports, and changes in inventories & discrepancy. ### Prices, labor market, and wages - CPI inflation peaked at 15.2 percent (y/y) in June 2008 and fell to 11.9 percent in June 2009. - Inflation remains elevated partly due to ruble depreciation and higher tradables inflation (excluding food); declines in food and energy prices and faltering domestic demand have reduced headline inflation. - Unemployment rate rose to 9.9 percent in May (seasonally adjusted). - Labor productivity growth (real GDP per unit employment) turned negative since early 2009, exerting downward pressure on real wages. - Real wages had been growing well above productivity on average for almost a decade; unit labor cost growth is slowing rapidly. ### External sector, exchange rate, and reserves - Since the onset of the crisis in September, the ruble has depreciated by around 15 percent against the U.S. dollar-euro basket. - Earlier movements: currency first depreciated by about 30 percent over December-January, then recovered; after appreciation it remained 5 percent more depreciated than its pre-crisis level. - Staff analysis suggests the ruble remains broadly in equilibrium, aided by an increase in projected medium-term oil prices implying a parallel appreciation of the equilibrium real effective exchange rate. - Current account balance largely stabilized at around $8 billion. - Gross international reserves declined from a peak of $598 billion in August 2008 to a trough of $375 billion in March 2009, before ticking up to over $400 billion by end-June. - Capital outflows reached $131 billion in the fourth quarter of 2008. - With oil export volumes stagnant and lower oil prices, export values fell; rapid import growth reversed sharply due to contraction in domestic demand and ruble depreciation. - In the first quarter of 2009, corporates were able to roll over nearly all of their foreign debt. ### Credit, banking sector strains, and financial stability - Overdue loans more than doubled since January, reaching 4.6 percent of total loans in May despite regulatory forbearance and anecdotal evidence of substantial evergreening of loans. - Controlling for depreciation’s impact on ruble value of FX loans, credit fell by 1 percent over the first quarter. - The contraction in credit affected both household and corporate sectors, particularly households. - Banks exhibited a strong preference for liquidity; banks drew down foreign assets to reduce foreign liabilities. - Reserve losses stopped and the ruble began to recover after tightening monetary policy and a one-step devaluation in January. - The CBR introduced regulatory forbearance by easing loan classification and provisioning requirements; non-standard definitions for nonperforming and restructured/renewed loans have masked loan-book deterioration. - CBR loosened accounting standards to limit banks’ mark-to-market losses and expanded access to unsecured loan auctions, increasing credit risk to the CBR. - Some small- and medium-sized banks were taken into receivership; combination of CBR liquidity and forbearance helped weather early crisis stages. ### Monetary policy phases, rates, and liquidity operations - Policy unfolded in three phases: accommodation; devaluation and tightening; gradual easing. - Accommodation: large liquidity provision (government auctions of excess budgetary funds to banks; CBR uncollateralized loans and guarantees; raised deposit-insurance limit). By mid-January, pace of reserve loss reached over $50 billion per month; total reserve loss since August amounted to over $200 billion. - Devaluation and tightening: toward end-January, CBR allowed a one-off 10-percent weakening of the effective exchange-rate band and declared it would defend the ruble at the weak bound. Interest rates rose—overnight interbank rates reached 28 percent at their peak. - Repo interest rates increased by almost 300 bps in February to around 12 percent; rates on unsecured loans rose by almost 500 bps to around 18 percent. - Tightening eased pressure on the exchange rate and reserves leveled off at around $380 billion. - Gradual easing: repo rates fell to 8¾ percent by late June; renewed inflows improved local liquidity and interbank lending; CBR uncollateralized loans being repaid ahead of schedule. Nevertheless, banks prefer holding deposits at the CBR rather than extending credit. ### Fiscal and financial support measures (selected programs and amounts) - Financial Sector Support Operations, 2008–09 (Announced amount; Actual use as of June 12, 2009; Gross Treasury financing need): - Deposit insurance: 200; 200; 200. - Purchase of assets (Mortgages from banks financed from the National Welfare Fund): 200; 0; 0. - Capital injection by MOF: 505; 205; 505. - Central bank lending: 1,309; 1,309; 0. - Bank loan/recapitalization: 1,787; 839; 0. - Liquidity support from MOF: 300; 155; 0. - Total: 4,301; 2,708; 705. - CBR crisis liquidity injections: new uncollateralized lending facility on top of Rub 200 billion rolled over via daily repos; as of June 12, Rub 720 billion in uncollateralized lending; other loans (nontraded collaterals) amounted to Rub 589 billion. - Average daily repo operations and CBR liquidity injection volumes increased markedly during the crisis (two-week moving averages shown). ### Regional spillovers - Russian slowdown adversely impacted regional partners through trade, financial, and remittance channels. - Strong trade links remain with Belarus, Finland, Kazakhstan, Moldova, and Ukraine; Turkmenistan hit due to decline in gas exports to Russia. - Financial channel effects: earlier benefits from Russia’s oil-driven external savings reversed; some countries (Kazakhstan) suffered investment losses. - Remittance link is especially strong for Tajikistan, Kyrgyz Republic, Georgia, Armenia, Belarus, Moldova, and Ukraine; sharp decline in construction in Russia led to large reverse migration, increasing unemployment pressures and demand for social services in home countries. *Italic: IMF staff report excerpt — _cr09246 - 1. Credit Indicators, 2006–09.* ### 10. Fiscal policy was expansionary in the second half of 2008, but the stimulus was ### _cr09246 - 10. Fiscal policy was expansionary in the second half of 2008, but the stimulus was ### Fiscal developments in late 2008 and early 2009 - Budgetary expenditures were heavily backloaded: "some 38 percent of expenditures were executed in the fourth quarter." - Fiscal policy provided a large demand stimulus toward the end of 2008, but retrenchment occurred in Q1 2009 following seasonal patterns. - The non-oil deficit of the general government fell from "some 6 percent of annual GDP in the fourth quarter of 2008" to "roughly ¾ percent of annual projected GDP in the first quarter of 2009" — "a withdrawal of over 5 percent of GDP." ### April 2009 supplementary budget and discretionary measures - A large supplementary budget was passed in April 2009 to support domestic demand, including: - Large discretionary increases in defense and security spending. - Anti-crisis measures aimed at stimulating activity by reducing taxes, extending support to strategic sectors, and enhancing social assistance. - As a result, "total expenditure is expected to increase by some 5 percent of GDP." - Excluding budgetary support to the financial sector, Russia’s announced discretionary fiscal stimulus is described as "one of the highest in the G-20." - Breakdown from the 2009 Supplementary Budget (Prel. Budget 2008 → 2009 Change): - "Total expenditures 2/ 18.7 23.9 5.2" - "National economy 2.5 4.0 1.6" - "Defense and security 4.5 5.5 1.0" - "General public issues 2.0 2.5 0.5" - "Social policies 0.7 1.1 0.4" - "Education 0.9 1.0 0.1" - "Health 0.7 0.8 0.2" - "Intergovernmental transfers 6.4 8.5 2.1" - "Other 2/ 1.1 0.5 -0.6" - Memorandum: "Nominal GDP (billion of Russian rubles) 41,668 40,512 ..." - Note: "2/ Includes the disbursement for the Housing Fund in 2008 (0.6 percent of GDP)." ### Near-term outlook and key macro projections - The Russian economy is projected to experience a deep recession in 2009, followed by a sluggish recovery; risks are to the downside. - Staff projection highlights: - "Real GDP is expected to contract by 6½ percent in 2009." - Growth projected to recover slowly over 2010. - Key Economic Indicators (2008 2009 2010): - "Real GDP (percent change) 5.6 -6.5 1.5" - "Current account (percent of GDP) 6.1 1.5 2.9" - "Inflation (e.o.p., percent change) 13.3 11.0 9.0" - "General government overall balance (percent of GDP) 4.3 -5.5 -5.0" - "World oil price (U.S. dollars per barrel) 97.0 60.5 74.5" - "Net capital inflows (billions of U.S. dollars) -133.0 -67.9 -25.8" - Additional projections and outcomes: - Imports are projected to fall steeply in 2009; import growth weakly positive in 2010. - With planned monetization of the fiscal deficit, capital outflows are expected to remain relatively high at "$68 billion." - Overall balance-of-payments deficit of "about $50 billion in 2009"; reserves would decline to "some $375 billion by end-year." - Nominal credit projected to remain relatively flat for the rest of 2009, implying "a drop of some 10 percent in real terms." - Headline inflation expected to decline slowly, "falling to 11 percent by year-end" 2009, with further decline in 2010. ### Risks to the outlook - Main downside risks identified: - Protracted global downturn and further declines in commodity prices could delay recovery and lower growth, particularly in 2010. - The planned fiscal relaxation might fail to stimulate private consumption amid income uncertainty. - Banks may continue to struggle to adjust balance sheets absent determined policy intervention, stifling credit expansion. - Large external debt amortization due in 2009 and 2010 could add funding pressures if global risk aversion renews. - Projected amortization of external debt (Billions of U.S. dollars): - "2009 2010" - "Total 124.3 98.9" - "Banks 52.7 34.1" - "Nonbanks 71.6 64.8" ### Financial sector policies and supervisory recommendations - Remaining supervisory weaknesses hamper the Central Bank of Russia (CBR) ability to assess banks’ portfolio deterioration, including: - Lack of comprehensive consolidated supervisory powers. - Generous accounting and provisioning rules limiting accurate gauging of asset quality and loan-loss reserves. - Shortcomings in reporting consolidated financial statements and monitoring off-balance-sheet activities. - Lack of adequate powers to monitor and supervise bank holding companies and sanction bank officers and directors. - Expected developments and policy needs: - Overdue loans expected to increase sharply, denting capital adequacy. - Government has set aside "Ruble 500 billion (1¼ percent of GDP)" to support bank recapitalization; modalities are being finalized. - Staff recommendations: - Undertake detailed reviews and mandatory systemic stress tests for large- and medium-sized banks using similar assumptions and the same point-in-time balance sheets to estimate viability and capital needs. - Develop regulatory guidance mapping supervisory actions as banks’ capital deteriorates to enable early planning by banks. - Develop contingency plans and resolution strategies; DIA to prepare for orderly disposition of assets from liquidated banks or DIA-assisted mergers and possible rise in deposit payouts. - Develop a communication strategy for rolling back regulatory forbearance and procedures for determining compliance with capital requirements after rollback. - Continue participation in international fora (e.g., Basel Committee) to improve coordination on regulation, resolution, and information sharing. - CBR view: CBR agreed the system is deteriorating but regarded problems as manageable within existing frameworks; no perceived need for systemic stress tests though ad-hoc stress testing is conducted. Draft legislation to expand CBR’s consolidated supervision authority is under review and expected to be presented to Duma later this year. ### Fiscal policy assessment and recommendations - Prior to the crisis, fiscal policy had become increasingly pro-cyclical due to pressures to spend oil wealth and failure to curb current expenditures. - A large fiscal expansion is underway: - Headline balance expected to swing from "a surplus of 4¼ percent of GDP in 2008" to "a deficit of about 5½ percent in 2009" — "a turnaround of nearly 10 percent of GDP." - Oil revenues projected to fall by "about 4¼ percent of GDP." - Expenditures set to rise by "over 5 percent of GDP in the second half of the year." - The non-oil deficit of the general government projected to increase by "5½ percent of GDP — reaching 13¾ percent of GDP." - Deficit monetized by drawing down the oil Reserve Fund, except for domestic borrowing "of up to 1 percent of GDP." - Concerns on reversibility and effectiveness: - The composition and size could become entrenched, making medium-term fiscal targets harder to achieve and returning to a highly procyclical stance. - To bring the non-oil deficit down to the authorities’ "4.7 percent of GDP medium-term target" would require "an adjustment in expenditure or non-oil revenues of some 9 percent of GDP over the next four years." - Accounting for pension reform financing (averaging "3 percent of GDP annually") and banking sector support, "the required adjustment could exceed 11 percent of GDP." - With high tax burden and non-statutory federal spending at "only 7¼ percent of GDP," such adjustment would require deep public sector reforms. - Staff’s recommended approach: - Keep the change in the non-oil deficit to "2–3 percent of GDP in 2009" and improve composition. - Reorient stimulus toward better-targeted and self-reversing measures to achieve similar impact with a smaller fiscal cost: - Reduce support to strategic enterprises and streamline non-essential defense outlays. - Reorient toward temporary increases in social transfers targeted on credit-constrained households. - Frontload infrastructure projects for which preparations are advanced, alongside strengthening procurement procedures. - Frontloading pension reform is appropriate if additional outlays are offset by reductions in less efficient spending. - If a smaller non-oil deficit is targeted in 2009, scope may exist to maintain stimulus in 2010 if needed; if growth outlook improves, some withdrawal of stimulus "of around 1 percent of GDP" would be appropriate in 2010. - Authorities’ stance: - Officials at the Ministry of Finance viewed spending pressures as likely to continue and the composition of the stimulus as suboptimal; they also worried about effective implementation in remaining months of 2009, implying possible underexecution. - No plans to introduce a supplementary budget aimed at reducing the size of the stimulus. - Decision to delay submission of the 2010 budget to the Duma until the fall due to exceptional uncertainties. *Source: IMF staff report content in _cr09246 - 10. Fiscal policy was expansionary in the second half of 2008, but the stimulus was* ### 21. To facilitate the large fiscal adjustment needed over the medium term, staff and ### _cr09246 - 21. To facilitate the large fiscal adjustment needed over the medium term, staff and ### Public-sector reforms and fiscal consolidation - Staff and the authorities agreed that reinvigoration of public-sector reforms is a priority to facilitate large fiscal adjustment. - Staff welcomed commitment to advancing reforms in the health and education sectors and noted IMF research showing scope for significant budgetary savings by improving expenditure efficiency, especially in healthcare and social protection. Public sector reforms in civil service, military, and education would also be instrumental in creating fiscal space. - Staff supports the authorities’ plan to gradually replace the current revenue-based oil taxation regime with a profit-based system (Annex III), which would better tailor taxation to differences in costs over time and across fields and better balance government oil revenue take against investment incentives. - A necessary precondition for adopting a profit-based oil taxation system is the introduction of transfer-pricing legislation consistent with OECD guidelines and a strengthening of enforcement capacity. ### Monetary policy: stance, risks, and recommendations - With inflation declining, there is room to ease the monetary policy stance, but the CBR should move cautiously in reducing interest rates because large liquidity injections associated with monetization of the fiscal deficit may create risks to external stability. - Estimated liquidity injections: - Monetization of the fiscal deficit by drawing down the oil Reserve Fund would represent an injection amounting to around 70 percent of base money during the remainder of 2009, under the assumption that the budget is fully executed. - Staff projects a net liquidity injection of around 35 percent of base money (after expected sterilization and repayment of uncollateralized loans). - Lower interest rates should help reduce bank funding costs and support the financial system, but initial direct impact on domestic demand may be limited because: - Banks facing mounting overdue loans and rising credit risk are likely to scale back credit supply. - General uncertainty is likely to reduce credit demand. - Risks to external stability: - Excessive reduction in interest rates, or renewed expectations of ruble depreciation (e.g., from a reversal of recent oil price increases), could induce banks and investors to shift into foreign exchange, putting downward pressure on the exchange rate. - CBR officials indicated readiness to halt interest rate reductions as needed to preserve external stability. - Staff welcomed increased exchange-rate flexibility and urged the CBR to keep monetary policy focused on reducing inflation: - Allowing the ruble to move flexibly in both directions helps avoid exacerbating short-term speculative inflows (carry trade). - Authorities should be prepared to let the exchange rate move in line with longer-term fundamentals, while temporary use of reserves can cushion abrupt shifts. - Staff urged refocusing monetary policy on inflation control, noting that prior orientation toward nominal exchange rate stability contributed to entrenched high inflation relative to G-20 peers and constrained mobilization of long-term ruble financing. - Authorities’ stance: - Agreed on the importance of reducing inflation and maintaining a higher degree of exchange-rate flexibility seen since the beginning of the year. - Felt it was premature to commit to allowing the exchange rate to fully respond to changing fundamentals or to commit to a timetable for moving to inflation targeting, given commodity dependence and price volatility. ### Structural reforms and investment climate - Boosting long-term growth potential depends critically on advancing structural reforms, including accession to the WTO, but the accession process appears to be losing momentum. - Staff observations: - Russia continues to score poorly on cross-country comparisons of the investment climate, partly due to perceived heavy government interference, limited competition, and lack of new entries fostering rent seeking. - Important reforms (civil service, public administration) appear to have stalled during the period of high oil prices; support for early WTO accession appears to have lost momentum. - As catch-up productivity gains diminish and the labor force is set to decline steadily because of unfavorable demographical factors, long-term growth will increasingly depend on boosting investment and improving the investment climate. - Staff encouraged maintaining an open trade regime and avoiding protectionist measures. - Authorities’ position: - Agreed on the need to move ahead with structural reforms; many reforms aimed at improving the investment climate and bolstering institutions are technically relatively well-advanced. - Implementation focus to be on areas critical to controlling public spending, notably health and education reforms. - Officials expressed frustration with the prolonged WTO accession process and acknowledged loss of momentum; shortly after the mission, Russia suspended its bilateral bid for WTO membership, seeking instead to join in partnership with Belarus and Kazakhstan as part of a customs union. ### Staff appraisal: crisis assessment, policy priorities, and lessons - Economic shock and policy environment: - The Russian economy has been hard hit by dual shocks as rapidly rising oil prices and massive capital inflows have suddenly reversed; the swing in growth has been much stronger in Russia than in its G-20 peers despite a much larger fiscal stimulus. - The depth of the crisis and large scope for countercyclical policies highlight both strengths (e.g., prior fiscal prudence) and weaknesses (e.g., regulatory and exchange-rate policies). - Financial sector and banking system risks: - Financial sector weaknesses and large external exposures have circumscribed the policy response; initial low-interest ruble credits and exchange rate intervention stabilized the banking system but led to unsustainable reserve losses and an eventual policy reversal with significant ruble depreciation. - Banks’ financial situation and loan portfolios are deteriorating at a notably faster pace. - Staff recommended a more proactive and concerted approach to tackle banking sector problems, including: - Mandatory, bottom-up stress tests of larger banks. - A roadmap of likely supervisory responses as bank capital deteriorates and problem loans increase. - Strengthening the CBR’s supervisory authority, including broader consolidated powers. - Greater willingness to compel bank closures and consolidation, leveraging comprehensive deposit insurance and the large number of small banks. - Despite explosive credit growth in recent years, the banking system remains small with credit-to-GDP at about 40 percent, implying that recapitalizing systemically important institutions is unlikely to pose a major fiscal burden. - Fiscal policy concerns and recommendations: - The planned fiscal relaxation is judged excessive: - Taking into account the projected cost of urgently needed pension reforms, the relaxation will increase the non-oil deficit by some 11-13 percent of GDP above the level prescribed by the government’s medium-term fiscal framework. - With non-statutory federal spending of only some 7¼ percent of GDP, consolidation on this scale would require unprecedented deep public sector reforms. - Staff urged scaling back the fiscal stimulus from 5½ to about 2½ percent of GDP and reorienting its composition toward measures that are self-reversing, balancing short-term cyclical support with the medium-term objective of prudent spending of oil wealth. - Risks of failing to rebalance include highly procyclical fiscal policy once private demand normalizes, excessive real appreciation, and stifled diversification away from primary commodities. - Monetary policy recommendations reiterated: - There is a case for continuing to reduce policy rates, proceeding slowly and taking into account ruble effects. - The CBR should manage large-scale monetization by allowing the large stock of maturing uncollateralized credits to expire. - The CBR should stand ready to support the ruble if unexpected developments (notably a renewed drop in oil prices) unsettle exchange rate expectations, allowing a further reduction in reserves. - Increased exchange rate flexibility since the beginning of the year has helped stabilize the balance of payments; interventions should be temporary. - Broader lessons: - Prudent taxation and saving of oil revenue windfalls and buildup of reserves left room for significant countercyclical fiscal expansion and allowed monetary policy to cushion initial shocks. - However, pre-crisis controlled ruble appreciation and regulatory shortcomings encouraged excessive foreign currency borrowing and a credit explosion via capital inflows. - The inflexible exchange rate policy led to entrenched high inflation, constraining availability of long-term ruble financing and increasing dependence on foreign financing for long-term investment. - Failure to advance reforms to improve the investment climate and promote diversification contributed to the depth of the crisis; little progress was made during the high oil price period to curtail government interference, increase competition, and reduce rent-seeking. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 34. Against this background, policy priorities—once the current crisis subsides— ### _cr09246 - 34. Against this background, policy priorities—once the current crisis subsides— ### Policy priorities - Refocus fiscal policy on the non-oil deficit, credibly anchoring it on a target that is sustainable from a long-term perspective. - Reorient monetary policy toward controlling inflation within the context of a fully flexible exchange rate policy. - Reinvigorate structural reforms, notably: - Public administration and civil service reforms. - Reforms of the judiciary. - Drive to gain early accession to the WTO. ### Growth, inflation, and real economy projections (selected) - Real GDP: 2006: 7.7; 2007: 8.1; 2008: 5.6; 2009: -6.5; 2010 (Proj.): 1.5 - Consumer prices (period average): 2006: 9.7; 2007: 9.0; 2008: 14.1; 2009: 12.3; 2010 (Proj.): 9.9 - Consumer prices (end of period): 2006: 9.0; 2007: 11.9; 2008: 13.3; 2009: 11.0; 2010 (Proj.): 9.0 - GDP deflator (average): 2006: 15.5; 2007: 13.9; 2008: 19.2; 2009: 4.0; 2010 (Proj.): 13.6 - Unemployment rate: 2006: 7.2; 2007: 6.1; 2008: 6.4 ### Public sector fiscal outcomes (percent of GDP) - General government: - Overall balance: 2006: 8.3; 2007: 6.8; 2008: 4.3; 2009: -5.4; 2010 (Proj.): -5.0 - Revenue: 2006: 39.5; 2007: 40.0; 2008: 38.4; 2009: 33.9; 2010 (Proj.): 35.3 - Expenditures: 2006: 31.2; 2007: 33.2; 2008: 34.1; 2009: 39.3; 2010 (Proj.): 40.2 - Primary balance: 2006: 9.1; 2007: 7.4; 2008: 4.8; 2009: -4.9; 2010 (Proj.): -4.4 - Non-oil balance: 2006: -4.5; 2007: -3.9; 2008: -8.3; 2009: -13.8; 2010 (Proj.): -14.7 - Non-oil balance excl. Yukos 1/: 2006: -4.5; 2007: -5.5; 2008: -8.3; 2009: -13.8; 2010 (Proj.): -14.7 - Federal government: - Overall balance: 2006: 7.4; 2007: 6.2; 2008: 3.5; 2009: -5.5; 2010 (Proj.): -5.0 - Non-oil balance: 2006: -3.9; 2007: -3.0; 2008: -7.5; 2009: -12.8; 2010 (Proj.): -13.6 - Non-oil balance excl. Yukos 1/: 2006: -3.9; 2007: -4.6; 2008: -7.5; 2009: -12.8; 2010 (Proj.): -13.6 ### External sector and balance of payments (selected, Billions of U.S. dollars) - Exports (total merchandise, f.o.b.): 2006: 303.6; 2007: 354.4; 2008: 471.6; 2009: 278.4; 2010 (Proj.): 320.8 - Imports (total merchandise, f.o.b.): 2006: -164.3; 2007: -223.5; 2008: -291.9; 2009: -199.8; 2010 (Proj.): -210.4 - External current account: 2006: 94.3; 2007: 76.2; 2008: 102.3; 2009: 18.3; 2010 (Proj.): 38.9 - External current account (percent of GDP): 2006: 9.5; 2007: 5.9; 2008: 6.1; 2009: 1.5; 2010 (Proj.): 2.9 - Net trade details (2006–10, selected): - Energy exports (2006–10): 2006: 190.8; 2007: 218.6; 2008: 310.1; 2009: 171.3; 2010 (Proj.): 202.0 - Oil (2006–10): 2006: 147.0; 2007: 173.7; 2008: 241.0; 2009: 136.8; 2010 (Proj.): 170.8 - Non-energy exports (2006–10): 2006: 112.8; 2007: 135.8; 2008: 161.5; 2009: 107.1; 2010 (Proj.): 118.9 ### Reserves and external metrics - Gross international reserves (billions of U.S. dollars): 2006: 303.7; 2007: 478.8; 2008: 427.1; 2009: 375.7; 2010 (Proj.): 397.2 - Months of imports (GNFS): 2006: 17.4; 2007: 20.3; 2008: 13.9; 2009: 18.0; 2010 (Proj.): 18.2 - Gross international reserves (billions of rubles, Table 5): gross international reserves across selected months, e.g., Mar. 2010 (Proj.): 11,348 (gross reserves) - Gross reserves (billions of U.S. dollars) (Table 5 monthly series): Mar. 2006: 303.7; Jun. 2006: 476.4; Sept. 2006: 489.8; Dec. 2006: 553.4; Mar. 2007: 562.3; Apr. 2007: 435.2; Dec. 2007: 390.4; Dec. 2008: 390.5; Dec. 2009: 364.7; Dec. 2010 (Proj.): 386.2 ### Fiscal operations detail (Table 3, percent of GDP) - General government revenue composition (2007–10, selected lines): - Total revenue: 2007: 40.0; 2008: 38.4; 2009: 33.9; 2010 (Proj.): 35.3 - Oil revenue: 2007: 12.9; 2008: 10.7; 2009: 12.6; 2010 (Proj.): 8.4; 2010 (another cell): 9.8 (note: table lists oil revenue and other years) - Non-oil revenue: 2007: 26.6; 2008: 29.3; 2009: 25.8; 2010 (Proj.): 25.5 - VAT: 2007: 5.6; 2008: 6.8; 2009: 5.1; 2010 (Proj.): 6.0; 2010 (other cell): 5.9 - Federal government (percent of GDP): - Total revenue: 2007: 23.3; 2008: 23.5; 2009: 22.3; 2010 (Proj.): 18.4; 2010 (other cell): 18.1 - Total expenditure: 2007: 15.9; 2008: 17.3; 2009: 18.7; 2010 (Proj.): 23.9; 2010 (other cell): 23.1 ### Monetary accounts and financial soundness (selected) - Broad money (ruble broad money, percent 12-month change): 2006: 48.8; 2007: 47.5; 2008: 42.2; 2009: 1.7; 2010 (Proj.): 21.5 - Base money (12-month change): 2006: 39.6; 2007: 33.1; 2008: 30.4; 2009: 2.9; 2010 (Proj.): 16.7 - Ruble broad money velocity (2006–10): 2006: 3.3; 2007: 2.9; 2008: 2.7; 2009: 2.9; 2010 (Proj.): 3.0 - Financial Soundness Indicators (selected): - Nonperforming loans to total gross loans: 2003: 5.0; 2004: 3.3; 2005: 2.6; 2006: 2.4; 2007: 2.5; 2008: 3.8; 2009 (As of April 1, 2009): 5.1 - Regulatory capital to risk-weighted assets: 2003: 19.1; 2004: 17.0; 2005: 16.0; 2006: 14.9; 2007: 15.5; 2008: 16.8; 2009: 16.9 - Return on assets: 2003: 2.6; 2004: 2.9; 2005: 3.2; 2006: 3.3; 2007: 3.0; 2008: 1.8; 2009 (As of Apr. 1, 2009): 1.3 - Return on equity: 2003: 17.8; 2004: 20.3; 2005: 24.2; 2006: 26.3; 2007: 22.7; 2008: 13.3; 2009: 10.0 ### External vulnerability and debt metrics - Total external debt (billions of U.S. dollars): 2006: 310.6; 2007: 465.4; 2008: 479.7; 2009: 444.9; 2010 (Proj.): 452.5 - Total external debt (percent of GDP): 2006: 31.4; 2007: 36.0; 2008: 28.6; 2009: 36.8; 2010 (Proj.): 34.0 - Current account (percent of GDP): 2006: 9.5; 2007: 5.9; 2008: 6.1; 2009: 1.5; 2010 (Proj.): 2.9 - External debt-to-exports ratio (Table 8): 2006: 104.8; 2007: 95.7; 2008: 92.8; 2009: 118.2; 2010 (Proj.): 91.7 - Gross external financing need (billions of U.S. dollars) (Table 8): 2006: 6.7; 2007: 3.6; 2008: 21.0; 2009: 68.1; 2010 (Proj.): 132.5 - Gross external financing need (percent of GDP): 2006: 1.1; 2007: 0.5; 2008: 2.1; 2009: 5.3; 2010 (Proj.): 7.9 ### Public sector debt sustainability (selected, percent of GDP) - General government gross debt: 2004: 23.1; 2005: 14.4; 2006: 9.1; 2007: 7.4; 2008: 6.5 - Baseline public sector debt: 2006: 9.1; 2007: 7.4; 2008: 6.5; 2009: 7.3; 2010 (Proj.): 7.8; 2014 (Proj.): 7.2 - Change in public sector debt (2006–14 projections, selected): 2006: -5.1; 2007: -1.7; 2008: -0.9; 2009: 0.8; 2010 (Proj.): 0.5 - Identified debt-creating flows (2006–14, selected): 2006: -5.4; 2007: -2.9; 2008: -0.4; 2009: 1.3; 2010 (Proj.): 0.5 - Primary deficit (excluding deposits in oil funds from revenue): 2006: -2.7; 2007: -1.6; 2008: 0.1; 2009: 0.1; 2010 (Proj.): 1.0 - Public sector debt-to-revenue ratio (2006–14, selected): 2006: 27.5; 2007: 21.7; 2008: 19.3; 2009: 18.8; 2010 (Proj.): 20.1 - Stress tests and scenarios: - Stress tests illustrated in Figure 5 include growth shock, primary balance shock, interest rate shock, combined shocks, and real depreciation plus contingent liabilities shocks. - Example baseline and scenario comparisons (from figure captions and notes): Primary Balance Shock—Baseline: -0.7; Scenario: 7.2; Historical: -17.4. No Policy Change scenario—Baseline: -0.3; Scenario: -1.4; Historical: 3.2. Contingent liabilities shock—30% depreciation. ### Key macroeconomic assumptions underlying projections (selected) - World oil price (U.S. dollars per barrel, WEO): 2006: 64.3; 2007: 71.1; 2008: 97.0; 2009: 60.5; 2010 (Proj.): 74.5 - Russian oil price (U.S. dollars per barrel): 2006: 61.1; 2007: 69.3; 2008: 94.5; 2009: 58.0; 2010 (Proj.): 72.0 - Nominal GDP (billions of rubles) (Table 6 projections): 2006: 26,904; 2007: 33,111; 2008: 41,668; 2009: 40,512; 2010 (Proj.): 46,718 *Sources: Russian authorities; and IMF staff estimates.* ### ANNEX I. RUSSIA’S EXTERNAL STABILITY AND COMPETITIVENESS ### ANNEX I. RUSSIA’S EXTERNAL STABILITY AND COMPETITIVENESS ### Recent Developments - Two most-recent CGER exercises found Russia’s real exchange rate (RER) broadly in equilibrium. - Fall 2008 CGER: RER in equilibrium. - Spring 2009 CGER: RER still in equilibrium, despite REER depreciating by around 12 percent. - Drivers and implications: - Projected long-term oil prices under the WEO dropped by around 30 percent between the two CGER exercises, from about $100 per barrel to $73 per barrel. - Studies of oil-exporting countries suggest elasticity of a country’s ERER with respect to the price of oil is typically around 0.4–0.5 percent. Given the drop in projected oil prices, this implies a 12–15 percent fall of Russia’s ERER—roughly equal to the ruble’s actual REER depreciation over the same period. - Projected long-term oil prices increased by 14 percent over March–May to around $83 per barrel, implying a 5–7 percent appreciation in the equilibrium RER; the actual REER appreciated by about 10 percent over the same period. - Conclusion: Given typical uncertainty, Russia’s exchange rate is still broadly in line with fundamentals. ### Further Analysis — Limitations of original CGER methodology for Russia - General concern: IMF (2008) CGER methodology may be ill-suited for an oil-exporting transition country. Specific concerns include: - Assessment of the underlying current account: - Original CGER assumes RER and current-account balance return to equilibrium within a relatively short time frame; this may be inappropriate for transition and oil-exporting countries experiencing trend real appreciation or aiming to smooth terms-of-trade shocks. - Estimating the underlying current account via staff medium-term projection (2014) and discounting projected real appreciation may be misleading. - MB (Macrobalance) approach: - Sample used in IMF (2008) MB regression includes few oil exporters, potentially understating impact of large oil-price changes for Russia. - ES (External Stability) approach: - Traditional ES takes most recent NFA as benchmark of a “sustainable” NFA level and derives current account that stabilizes NFA at that level; may be inappropriate for oil exporters (exhaustible resources) and transition economies (catch-up productivity gains). - Determining appropriate NFA benchmark for Russia is challenging and may require a more nuanced approach. - ERER approach: - IMF (2008) ERER uses fixed-effects panel techniques and implicitly assumes RER in each country has been, on average, in equilibrium over the sample period—problematic for transition countries with large trend appreciation. ### CGER exercises for Russia — modifications and additional analysis - Modifications applied in Fall 2008 and Spring 2009 CGER exercises to address concerns; staff additional analyses summarized below. - Underlying current account (alternative estimation): - Instead of relying on medium-term projections, estimate underlying current account by taking actual 2008 balance and stripping temporary factors. - For Russia: recorded 2008 balance of 6.1 percent of GDP corrected for (i) unusually high oil prices and (ii) recent positive output gap → resulting underlying balance is 3.9 percent of GDP. - This annex relies on the 3.9 percent of GDP estimate (more conservative than Spring 2009 CGER estimate of 5.2 percent). - MB approach (alternative specifications): - Spring 2009 CGER adopts a specification allowing different coefficients for oil-producing countries and uses a sample with more oil producers. - Staff estimated further regressions using samples dominated by oil exporters and replaced oil balance/GDP with simple oil prices to avoid endogeneity. - Results broadly agree: Russia’s underlying current account balance generally in line with fundamentals-based norm, confirming RER in equilibrium. - Note: CGER specification result cited compares CGER current-account norm (3.0 percent of GDP) to the 3.9 percent underlying current account from this annex; using the CGER’s less-conservative underlying estimate (5.2 percent) would suggest greater undervaluation. - ES approach (wealth- and annuity-based variants): - Alternative ES variant considers overall wealth including net present value of future oil-related cash flows; sets primary non-oil current account equal to annuity value of this wealth. - Three annuity measures commonly considered in fiscal literature: - Constant annuity as a proportion of GDP. - Constant annuity in real terms. - Constant annuity in real per capita terms. - Russia’s total wealth estimated by staff to be around 220 percent of GDP in 2008 prices; annuity value of this wealth ranges widely from 2–9 percent of GDP. - Implication: Estimated current-account norm and implied exchange-rate assessment vary widely depending on benchmark; approach is unreliable as a firm indicator due to arbitrariness in benchmark choice. - ERER approach (alternative wage-based regression): - Staff considered an additional regression with dependent variable = USD wages (comparable across countries), wider sample, and explicit allowance that transition countries were off-equilibrium over the sample. - Results: after the 2008 real depreciation, USD wages in Russia were 2 percent below equilibrium; CGER approach suggests an undervaluation of 1 percent. Both indicate RER roughly in equilibrium. - Equilibrium Dollar Wage (staff calculations, 1994–2008): - Actual Wage (U.S. dollars) series presented for 1994–2008 with specific values for each year (e.g., 1994: 137; 2008: 538). - Equilibrium wage (U.S. dollars) series presented for 1994–2008 with specific values for each year (e.g., 1994: 224; 2008: 547). - Equilibrium ratio (percent) series presented for 1994–2008 (e.g., 1994: 61; 2008: 98). - Source: IMF staff calculations. 1/ At December-2008 exchange rate. *Prepared by Hajime Takizawa and Andrew Tiffin.* --- ### ANNEX II. ANCHORING LONG-TERM FISCAL POLICY ### Background - Crisis-driven fiscal deviation: - 2009 crisis required large deviation from medium-term budget framework; fiscal deficit not sustainable in the long run. - Fiscal risks include large additional outlays associated with pension reform, rising healthcare costs, and sizable infrastructure gaps. - Need for a credible fiscal anchor to underpin a sustainable exit from sizable fiscal stimulus and address sustainable and equitable use of Russia’s exhaustible oil wealth. - Specifics of budget framework changes: - Authorities temporarily suspended deficit limits in the medium-term budget to accommodate 2009 stimulus and realistic medium-term adjustment. - Federal government non-oil deficit limit of 4.7 percent of GDP originally envisaged for 2011 was delayed until 2013. - This limit reflects long-term considerations: sustainable consumption of oil wealth = 3.7 percent of GDP and borrowing limit = 1 percent annually. - Fiscal position and sustainability concern: - Low public debt: 6½ percent of GDP in 2008. - Oil funds savings: estimated at over 16 percent of GDP at end-2008. - Projected increase in general government non-oil deficit to 13¾ percent of GDP in 2009 is unsustainable and results in an explosive debt dynamic. ### Establishing a credible long-term fiscal anchor — rationale and recommendation - Standard DSA limitations: - Considerable fiscal risks render conventional debt sustainability analysis (DSA) inadequate for assessing long-term fiscal solvency in Russia. - Given low initial debt, a standard DSA could allow sizable debt increases if stabilized later, but that is risky given: - Pension reform fiscal cost estimated at 3 percent of GDP annually on average over the next 40 years. - Long-term spending pressures from rising healthcare costs and infrastructure gaps. - High uncertainty regarding long-term oil prices and economically viable oil reserves. - Conservative alternative — Permanent Oil Income Model (POIM): - Recommend a cautious approach: framework based on POIM that stabilizes government consumption out of oil and financial wealth. - POIM characteristics: - Suited to establishing long-term fiscal benchmark for Russia. - Conservative (does not allow build up of public debt); staff views this as appropriate given fiscal risks. - Sustainable non-oil deficit level under POIM is an indicative benchmark; allows temporary deviations to respond to shocks. - Level of benchmark should be periodically re-assessed; perform sensitivity analysis on key assumptions (long-term oil price, interest and growth rates). - Staff calculations and implications: - POIM assumes gradual adjustment in general government primary non-oil deficit of about 1.9 percent of GDP per year until 2015 and limits government consumption in each period to implicit return on government wealth thereafter. - Under baseline projections of oil prices, and long-term growth and interest rates, framework implies sustainable long-term level of non-oil primary deficit of 1½ percent of GDP. - Table 1 and Figure 2 referenced for details. - Alternative adjustment paths possible: more frontloaded consolidation could permit a somewhat higher long-term sustainable deficit; delaying adjustment requires larger consolidation later to reach an even lower sustainable level. - Consistency with Budget Code deficit limit: - POIM implies that the 4.7 percent of GDP deficit limit in the Budget Code is not sustainable forever. - While a 4.7 percent of GDP non-oil deficit could keep public debt low for some time, it is not indefinitely sustainable; long-term simulations indicate public debt increases unsustainably as oil runs out. - The 4.7 percent of GDP limit could serve as an intermediate target while non-oil deficit is gradually reduced to sustainable levels. - Forthcoming medium-term budget key to signaling commitment to long-term fiscal solvency, sustainable consumption of oil wealth, and intergenerational equity. ### Quantitative sensitivity and scenarios (staff stress tests) - POIM baseline and stress-test outcomes (as reported): - Baseline scenario assumes June 2009 WEO oil price projections and implies sustainable non-oil deficit of about 1.6 percent of GDP. - Stress tests based on long-term real Urals oil prices: - US$40 per barrel → sustainable non-oil deficit of 1.1 percent of GDP. - US$100 per barrel → sustainable non-oil deficit of 1.9 percent of GDP. - Results presented in relation to total GDP (not non-oil GDP) due to lack of reliable non-oil GDP estimates. - Results broadly consistent with earlier estimates of sustainable government consumption (Country Report No. 06/430). *Prepared by Daria Zakharova.* ### Annex II. Box 1. The Permanent Oil Income Model ### Annex II. Box 1. The Permanent Oil Income Model ### Purpose and framework - The POIM applies the permanent income hypothesis developed by Friedman (1957) to decide how to allocate government wealth (including oil in the ground) across generations. - Objective: preserve the value of government wealth for future generations by limiting consumption in each period to permanent income (the implicit return on government wealth). - Basic POIM implication: a constant per capita level of the primary non-oil deficit financed by perpetual income from oil wealth. - Limitations noted: does not allow for intergenerational transfers of non-oil wealth; countries may deviate temporarily from the benchmark due to shocks. - Policy role: offers a simple, intuitive sustainability benchmark to guide longer-term fiscal policy and to evaluate risks and options for returning to a sustainable path while avoiding sharp adjustment. ### Key parameters and calculations (as presented) - Net financial assets (NFA; percent of GDP) 2008 1/10 - Real return on assets (percent)4 - Long-term GDP growth rate (percent)3 - Long-term Ural's oil price (U.S. dollars per barrel; based on WEO prices)80 - Long-term gas price (per 1000 cubic meters, WEO)200 Oil sector - Proven/unproven reserves (billions of barrels) 2/156 - Years until depletion 42 - Present value 2008 of future oil cash flow accruing to government (billions of U.S. dollars)2958 Gas sector - Proven reserves (billions of cubic meters)43300 - Years until depletion75 - Present value 2008 of future gas cash flows accruing to government (billions of U.S. dollars)403 Total - Energy wealth (billions of U.S. dollars)3362 - NFA (billions of U.S. dollars)168 - Total net wealth (NFA plus energy; percent of GDP)211 - Source: IMF staff calculations. - Footnotes shown in source: 1/ Reserve and National Welfare oil funds net of public debt. 3/ BP Statistical Review of World Energy, June 2009. 2/ Estimated based on proven oil reserves: 79.4 billions of barrels in 2008 (BP Statistical Review of World Energy, June 2009), and undiscovered reserves: 77.4 billions of barrels in 2000 (The U.S. Geological Survey, 2000). ### POIM scenarios and fiscal projections (summary of figures and scenarios) - POIM is based on the June 2009 World Economic Outlook oil prices. - Scenarios described: - POIM (sustainability benchmark based on permanent income). - "Unchanged policies" scenario: assumes general government non-oil primary deficit stabilizes at its 2009 level. - "Deficit at 4.7%" scenario: assumes the deficit is stabilized at 4.7 percent of GDP from 2013. - Key graphical findings (as presented): - Under unchanged fiscal policies, oil funds would be depleted by 2013 and public debt would build up unsustainably to finance deficits. - Oil price required to balance the budget would remain above the WEO oil price in projections. - Projected paths shown for: Non-oil primary deficit, Net wealth, and Government financial wealth under the three scenarios (POIM; Unchanged policies; Deficit at 4.7%). ### Policy implication (from POIM) - A fiscal framework anchored to the sustainability benchmark (POIM) helps evaluate risks and alternatives and provides guidance for returning to sustainable fiscal paths while avoiding sharp adjustments. --- ### Annex III: Russia’s Oil Taxation System ### Background and fiscal context - Concerns: low investment, falling production, and fiscal regime effects prompted a review of the oil taxation system. - Total revenue from upstream oil activity was 9.5 percent of GDP in 2008. - Revenue composition (Percent of 2008 total): - Mineral extraction tax (40%) - Export duty (43%) - Corporate income tax (17%) - From the three taxes combined, the government receives 90 percent of each additional dollar of export earnings when the Urals oil price exceeds $25 per barrel for a field with oil depletion below 80 percent. - Assessment: the top marginal rate is high by international standards and is triggered by a relatively low oil price; rising production costs and maturing fields make the revenue-based system particularly onerous on high-cost fields and may have contributed to declining investment and production. ### Model setup and comparative regimes - Simulation uses three illustrative oil field examples: low-cost (traditional West Siberia), high-cost (new development in East Siberia), very high-cost (continental shelf). - Regimes evaluated: - Current Russian regime (includes revenue-based instruments: mineral extraction tax and export duty, company income tax). - Russia 2007 (regime prior to 2007). - Russia Alternative (an alternative profit-based regime). - International comparators (various countries' regimes applied to the examples). - Assumptions: WEO oil prices until 2014 and constant real prices thereafter. - Summary table items (as presented): - Royalty: 419 Russian rubles/mt * (Urals/bbl - $15) / 261 (Russia) - Royalty: 419 Russian rubles/mt * (Urals/bbl - $9) / 261 (Russia, 2007) - Royalty: 10 (Russia Alternative) - Export duty: 0–650–650 (Russia / Russia 2007 / Russia Alternative) - Company income tax rate: 20 24 30 (Russia / Russia 2007 / Russia Alternative) - Supplementary profit tax: 0 0 R-factor based 1/ (Russia / Russia 2007 / Russia Alternative) - Proportion of profit-based revenue 2/ : 15 15 78 (Russia / Russia 2007 / Russia Alternative) - Footnotes (as presented): 1/ R-factor definition and use; 2/ Estimated from simulation model using the low-cost project and WEO-based Urals oil price projections. ### Model results — headline findings - Overall tax burden: - Low-cost project: current regime yields a high average effective tax rate (AETR) but below many other countries; Russia Alternative has a very similar AETR. - High-cost project: current regime AETR is substantially higher—now above all other countries in the sample—reflecting little change in government revenue despite lower pre-tax net cash flows. The alternative regime AETR is relatively unchanged due to reliance on profit-based instruments. - Very high-cost project: not economical under WEO oil prices for any regime—the AETR exceeds 100 percent. - Progressivity (responsiveness of government revenue to project profitability): - Current Russian system: government “take” increases with profits driven by oil prices, but if profits rise because costs fall, the government share declines slightly (undesirable). - Russia Alternative: displays desired responsiveness to costs (government share rises when profitability increases due to cost reductions). - Investor risk measures: - Hurdle price defined: oil price necessary to deliver an after-tax rate of return of 12 percent. - Hurdle price increases considerably as project costs increase. - Russia Alternative yields a lower hurdle price, particularly for the very-high cost project. - Maximum viable operating cost at a 12 percent after-tax return: - Under the current regime, oil fields with operating costs above $1.80 per barrel are not viable given exploration and development costs for the high-cost project. - Under the alternative regime, this maximum viable operating cost rises to $15 per barrel. - Other risk measures (payback period, tax-induced risk of uneconomic outcomes) point to similar conclusions. ### Synthesis of model implications - A profit-based regime could: - Broadly maintain or increase government take from highly profitable projects. - Expand the range of oil fields that are viable by reducing the tax burden on marginal projects. - Reduce key measures of investor risk (lower hurdle prices; higher maximum viable operating costs). - Provide automatic responsiveness to changing price and cost conditions, reducing the need for frequent discretionary changes and increasing certainty for investors. ### Transition arrangements and administrative considerations - Authorities see merit in moving toward a profit-based regime but need to strengthen administrative capacity first. - Required steps include: - Tighten transfer pricing rules and align them with OECD guidelines. - Strengthen administrative capacity to enforce rules. - Safeguards for revenue during transition: - Apply the new regime to new fields only, keeping the current system for existing fields. - Enforce strict ring-fencing rules to prevent profit-shifting between fields under different regimes. - Intermediate/minimal reforms that could be implemented sooner: - Further lower tax rates for fields in frontier regions with higher development and extraction costs. - Use other proxies for costs (in addition to field location and depletion), such as size of recoverable oil reserves. - Explore making some costs deductible against the mineral extraction tax or export duty as a means of transitioning to a profit-based regime. *Source: IMF staff report excerpts as provided in the content unit.* ### 1. World Bank Group activities in Russia are currently guided by the three-year ### _cr09246 - 1. World Bank Group activities in Russia are currently guided by the three-year ### Overview and next CPS phase (FY10–12) - The existing Country Partnership Strategy (FY07–09) was endorsed by the Bank’s Board in December 2006. - The next phase (FY10–12) will build on achievements and is under discussion with the Russian Federation, likely to rest on: - (i) extension of the existing program, and - (ii) possible new Bank support to the Government’s anti-crisis and broader modernization agenda. ### Extension of existing program — instruments and modalities - Increased use of instruments that leverage World Bank Group knowledge, project management, private sector expertise and AAA rating, notably guarantees to reduce the cost of borrowing for public infrastructure financing. - The Federal Government is expected to conclude the first test case of the “new modalities”: projects financed under a Russian Federation budget line, together with fee-based services for project appraisal and implementation or technical assistance operations at federal or sub-national level. - Fee-based services and reimbursable technical assistance are core elements of the extension strategy. ### Possible new World Bank financing and thematic priorities - Given pressure on fiscal reserves and external position from the global financial crisis, Russia might seek new World Bank financing to: - modernize the economy, - increase the efficiency of public expenditures, - strengthen Russia’s post-crisis position. - Likely thematic focuses include: - effectiveness of public expenditures, - social programs and support to vulnerable groups, - management of sub-national public finance. ### Regional engagement and constraints - Substantial developmental challenges persist across many Russian regions; federal government encourages deeper Bank Group involvement in regions. - Central theme of extended CPS: select regions — economic analysis (growth and business environment diagnostics), regional development strategies, and related investment projects. - Sub-national borrowing and new fee-for-service arrangements for investment and policy advice likely to remain at current levels due to fiscal and liquidity constraints in the regions. - IFC and MIGA operations are in very high demand but face headroom constraints; Russia is IFC’s and MIGA’s largest exposure. ### Four primary CPS objectives - The CPS will continue to support four primary objectives: - (a) diversifying the economy for sustainable development and growth (formerly, “Sustaining Rapid Growth”), - (b) improving public sector management and performance, - (c) improving the delivery of social services, - (d) enhancing Russia’s global role. - The first three pillars align closely with the previous Country Assistance Strategy (CAS) and the government’s Medium-Term Economic Program, with particular regional focus. The fourth pillar concerns Russia’s integration in the world economy and donor community. ### Major areas of Bank Group activities by CPS strategic pillar — (a) Diversifying the economy for sustainable development and growth - Macroeconomic policy, fiscal sustainability, and management of external inflows: - Periodic Russian Economic Reports, on-demand policy notes, and knowledge sharing. - Technical assistance on alternative uses for windfall oil revenues and institutional framework for managing a diversified portfolio of foreign assets. - The Bank finished a study on long-term fiscal risks and fiscal sustainability. - In April 2008, the Bank of Russia and World Bank Treasury signed a fee-based services agreement for Treasury technical support in internal investment management capacity for a period of 3 to 4 years. - The Bank provided lending and TA for securities market regulation, financial sector strategy (government assets and liability management, including reserves and stabilization funds management), and insurance and banking supervision; fee-based TA to the Central Bank for payments system development and monitoring. - Investment climate monitoring and policy advice: - Continued periodic BEEPS surveys, regional investment climate assessments, and administrative barriers studies by FIAS for interested regions. - Bank and MIGA can work regionally on capacity building and investment promotion programs to attract FDI (example: Rostov Region). - WBI to continue capacity building related to investment climate assessments. - Energy efficiency: - Bank and IFC completed a study on energy efficiency providing analysis and policy recommendations. - Ongoing energy efficiency advisory project in the North-West region to equip four oblasts with methodology and tools for regional energy efficiency agendas. - Government investment and PPPs: - Ongoing investment projects support land registration and development of a national cadastre. - Regular and reimbursable TAs to support PPP development across sectors. - Largest Bank fee-for-service portfolio belongs to the City of St. Petersburg (Western High Speed Diameter, Orlovsky tunnel, NADEX and Pulkovo airport). - Continued cooperation with VneshEconomBank (VEB) on PPP joint activities and potential partial credit guarantee support for infrastructure funding. - Support for an e-learning PPP program via the Higher School of Economics of Moscow targeting federal and regional stakeholders and CIS countries. - Support for microfinance sector development focused on financial cooperatives and their integration into the financial system. - Regional growth strategies and barriers to growth: - Two major knowledge events on regional development strategies held in early 2008: discussion of World Development Report on regional disparities and a Regional Development Strategies workshop. - Completion of a Country Economic Memorandum on sub-national barriers to growth and regional agglomerations. - Fee-for-service arrangements to support regional investment strategies and growth analyses; new analytical work on internal migration as part of a CIS-wide engagement. - Supporting priority regional investments: - IFC/Bank Sub-National Development Program to support priority regional public investments, direct lending to well-performing regions and municipalities without sovereign guarantees. - Three sub-national operations completed to date (two in the Chuvash Republic and one in Petropavlosk municipality (Kamchatka)). - One operation (Mariy El) approved by the Board and a credit agreement signed; another (Mytischi) expected to be approved by the Board by end of the fiscal year. - Infrastructure focus: transport and logistics, municipal infrastructure; MIGA can support FDI in sub-sovereign infrastructure including water and solid waste sectors. - Potential partnership with VEB for joint project preparation and support. - Direct support to the private sector (IFC priorities): - Finance projects with spill-over effects (infrastructure, financial markets), sectors of comparative advantage (processing of natural resources, knowledge economy), and projects increasing range/quality of products outside Moscow. - Concentration in financial sector with priorities: - (i) building long-term relationships with medium-sized independent private regional banks to increase competition and services; - (ii) supporting specialized banking products: mortgage financing, consumer finance and leasing; - (iii) supporting privatization of state-owned banks as requested; and - (iv) supporting new financial instruments such as partial guarantees of local currency bonds and securitization. - IFC financing in form of long-term senior loans and selected subordinated loans to strengthen bank balance sheets and reach SMEs. - IFC advisory work and FIAS: - Private Enterprise Partnership and FIAS technical assistance objectives: - (a) increase development impact of investments via local supplier strengthening and community development around large investments; - (b) build capacity of private banks to deliver new products, including mortgage finance and energy efficiency financing; - (c) improve corporate governance and environmental sustainability with banks and real sector clients, including IFC investees. - FIAS to continue working with select regions to improve business climate and implement policies to develop land and commercial real estate markets. - MIGA political risk guarantees: - Continued support for foreign investors in infrastructure in coordination with the Bank. - Exploration of opportunities to support capital markets transactions including asset-backed securitizations. - Promotion of foreign bank expansion in the Russian banking sector. - Potential further involvement areas: manufacturing, agribusiness and services. ### Major areas of Bank Group activities by CPS strategic pillar — (b) Improving public sector management and performance - Continued engagement to modernize selected public sector institutions, improve government administration, judiciary, local self-government, and budgetary management at federal and sub-national levels, with expanded regional engagement. - Modernizing public sector institutions via completion of on-going projects in tax modernization, customs development, cadastre and registration, fiscal federalism, performance-based budgeting, treasury development, and a statistical development project. - Administrative reform support: - Continued close engagement on administrative reform at federal and sub-national levels, including coordination and implementation of donor funds. - Emphasis on bringing Bank and international expertise to government administrative reform program, with sub-national focus (Southern Federal Okrug and North-West regions). - Fee-based advisory service supported Khanti-Mansiysk Okrug-Yugra on administrative streamlining and functional reviews; similar services may be developed with other regions. - Support for regions that cannot afford fee-based services provided through a DFID Trust Fund running from 2007–10. - Analytical support on public expenditure effectiveness, transparency and accountability: - Public Expenditure Review (PER) requested by the Ministry of Finance focusing on overall structure and efficiency of public expenditures with particular focus on the wage bill, education, and transportation expenditures; potential development into a programmatic exercise. - A social expenditures review on subnational expenditures on education, health and social assistance pursued in close coordination. - Budgetary reform assistance: - Ongoing assistance to federal and some regional governments on budgetary reform and performance-based budgeting. - Partnership in scaling up the Fiscal Federalism Project (now financed by the Russian government) and its expansion to the municipal level. - Local self-government reform and municipal development: - Dialogue and international experience sharing on local self-government reform. - Launched study monitoring and assisting local-self government development in Perm, Penza, and Adygeya regions. - Engagement with regions and municipalities based on new modalities and discussion of replicating Fiscal Federalism Project model for municipal capacity building. - Investments in municipal development via completed and ongoing projects: Municipal Heating, Municipal Water and Wastewater projects; Saint Petersburg Economic Development Project; Housing and Communal Services project awaiting government signature; possible regional subnational projects on water and heating upgrades; proposed Cultural Heritage II project (FY09). - Stavropol pilot Local Initiatives Support project improving settlement-level social infrastructure; work with Ministry of Regional Development on national scaling-up. - Judicial reform: - Coordination of donor funds and regional cooperation for judicial reform. - Approved project complements 2007–11 Federal Targeted Program for judicial modernization, focusing on dispute resolution efficiency and judicial transparency (FY07). - Complementary grant from the Government of Japan to support Perm Krai and Leningradskaya Oblast on demand-side justice sector issues such as legal aid to the poor and juvenile justice. - Planned partnership with the Chairman of the Supreme Commercial Court and the Ministry of Economic Development to support drafting framework legislation on administrative dispute resolution, complaints handling, and individual bankruptcy law. - Anti-corruption: - As a coherent national-level anti-corruption program may take shape, the Bank may explore possible constructive contributions to anti-corruption initiatives. *Source: _cr09246 - 1. World Bank Group activities in Russia are currently guided by the three-year* ### 8. In addition to continued general cooperation with the federal government, the Bank ### _cr09246 - 8. In addition to continued general cooperation with the federal government, the Bank ### Sub-national focus on social service delivery - The Bank will concentrate much of its support for improving social service delivery at the sub-national level. - The Government has prioritized the social sector and social services in its medium-term program; primary responsibilities and initiatives for reform in these services will be at the sub-national level. - Main activities: continuation of work in poverty, education, and health in cooperation with the regions. - Recent additional activities: monitoring of labor market developments (at the federal and regional levels), technical assistance for design and monitoring of active labor market programs. - Monitoring of social trends and project design for improvement of quality of social services at the local level will be continued in the Southern Federal Okrug and in other regions under fee-based services arrangements. ### Poverty work - Continuation of the poverty work in cooperation with Rosstat and federal ministries, with emphasis shifted to the regional level (in cooperation with DFID). - The Bank will work directly with regions on monitoring poverty and improving social assistance programs aimed at better targeting. - Regional social protection strategies for Tver and some other regions will be developed with Bank assistance. - Successful regional cooperation models can be scaled up to similar regions. ### Health sector engagement - Continue engagement on adult health and development of a national strategy to improve the health of the population, aiming to reverse strongly negative trends in premature mortality and morbidity. - Assist in design and implementation of practical mechanisms for family support, preventive social welfare and child care at federal and regional level (jointly with international donors). - Additional advocacy, public awareness and information sharing with government leaders, public figures, private sector and NGOs to support needed government policies. - Advise federal and regional authorities on risk pooling, insurance, and sustainable health financing. - IFC will continue working with private companies on programs for occupational health, including HIV-AIDS issues. - Implement on-going projects in the health sector and offer to scale up or modify existing models at the sub-national level as a service to regions. - Support development of public-private partnerships (PPPs) in health via TA from the Bank and direct financing by IFC to PPPs and/or purely private providers. - Apply lessons from the TB/AIDS project through focused regional interventions and TA. - Support a few regional projects for removing environmental hotspots and addressing other environmental concerns posing major health risks. ### Education and vocational training - Complete current projects in education designed to modernize the system and improve vocational training. - Meet regional demands for sub-national support for education reform. - Regional TA and possible projects could focus on improving systems for professional and vocational education, accompanied by parallel assessments of local labor markets to improve local professional labor supply quality. - Another focus: pre-school education and early childhood education. - The recently completed Youth Strategy by the Bank provides recommendations for improvements in youth policies, with possible applications to Russia in education and training. ### Housing, communal services, and infrastructure - Bank support in infrastructure will largely focus on improving quality of utility services and housing. - Large portfolio focused on improving heating, water, wastewater, and other municipal services in selected regions. - Recent completions: Municipal Heating, Municipal Water and Wastewater projects. - Approved by the Board and awaiting government signature: the Housing and Communal Services project that aims to support reforms and investments in HCS on grant basis allocated to regions competitively. - A large share of sub-national lending is expected to focus on improving these services. ### IFC PEP program, housing finance, and energy efficiency - IFC’s PEP program is focusing on two new product platforms in Russia: housing finance and energy efficiency, complemented by IFC investments. - The Primary Mortgage Development Project is working to streamline the mortgage lending process in Russia. - IFC's Sustainable Energy Efficiency Program in Russia combines advisory and investment capacity: makes credit lines available to banks for on-lending for energy efficiency projects and provides technical assistance to banks and private companies to raise lending volumes for energy-saving projects. - The program has already disbursed its first credit line to Center Invest Bank in Rostov, and currently has a US$60 million pipeline of potential deals across all regions of Russia. - IFC additional programs in Russia include support for corporate governance in the banking sector, improvement of forestry management practices in the Northwest, and development of local suppliers to the mining sector in Magadan. ### Enhancing Russia’s global role - Strong commitment to support Russia’s increasing global role and assist in fulfilling global commitments. - Continue cooperation to support Russia’s emergence as an international donor and active member of multilateral organizations; assist in establishment of mechanisms and implementation of actions from Russia’s global engagements (Climate Change and Biodiversity Conventions, pandemic diseases initiatives). - Share Bank analysis and advocacy directed towards traditional DAC donors with Russian experts. Key Bank engagements: - Assistance in formulation of an ODA strategy for Russia as emerging donor: continue to assist Russia and cooperate on design of Russia’s development aid strategy and establishment of a national ODA system; support includes training/capacity events, information sharing, and advisory services; work supported by Russia as a Donor Initiative DFID TF. - Implement an “externally funded staff development program” for building Russian Government capacity for aid policy development and aid management. - Government counterparts to be involved in policy dialogue on global food crisis and climate change. - Beginning with a high-level Russia-WB-OECD Emerging Donor Meeting in April 2006, assist Russia in organizing development aid seminars and international events; participate in preparation and delivery of Spring 2010 international conference on Emerging donors jointly with Russia and OECD. - Provide access to the Bank’s instruments for channeling Russian developmental assistance: engage on international policy initiatives developed under Russia’s G-8 presidency, including priority themes—quality of education, improved access to energy by vulnerable groups, and controlling the spread of infectious diseases. - Help prepare contributions to multilateral TFs such as Global Emergency Food Facility, the Education-For-All/Fast Track Initiatives; ensure effective implementation of Russia supported programs like Malaria control in Africa, Global Village Energy Partnership, Quality of Basic Education (READ). - Expand preparation of joint Russia-Bank aid initiatives in Central Asia, including blood banks and labor migrants support. - Following increased Russia’s contributions to IDA15, work on strengthening ownership of IDA among Russian policy makers. - Assist Russia in developing procedures and mechanisms for implementing activities under the Climate Change and Biodiversity Conventions; TA provided on introduction of low-carbon technologies and climate change mitigation. - If the government introduces financial instruments for low-carbon technologies, the Bank would support preparation and implementation of carbon-finance projects. - There are three GEF projects in the Bank’s pipeline awaiting establishment of a legal and institutional framework for their introduction at the regional level with federal oversight. - Continue participation in the Ministerial Conference on Forest Law Enforcement and Governance in Europe and North Asia. - IFC and MIGA to support linking Russian companies to global markets: IFC to support reputable Russian clients investing in emerging markets; MIGA to proactively engage Russian companies planning to invest in emerging markets. ### Focus on Russian regions - The Bank is identifying a small sub-set of 6–10 regions as targets for concentrated work programs; regions selected from wealthier, middle income, and poorer areas. - Selection criteria: (i) willingness and commitment of regional administration to work with the Bank; (ii) past history of successful cooperation; (iii) reform-orientation and competence of regional administration; (iv) strategic importance of the region for Russian development and existence of similar regions for scaling up; (v) region’s creditworthiness and potential interest in Bank operations (for wealthier or middle income regions). - After initial engagement, strategic directions and modalities of cooperation will be included in joint Memoranda of Understanding to be signed with leaders of focus regions. - Bank regional involvement: combination of targeted AAA on diagnostics of local economy and investment climate, development of regional strategies, and selected lending operations. Engagement with poorer regions: - World Bank Group will concentrate some work in poorer Russian regions; list of priority regions will include some poorer regions. - IBRD engagement in poorer regions lacking creditworthiness will depend on opportunities for participation in federal programs or coordination of donor funds. - IFC will make special efforts to support private sector activities in poorer areas. - For poorer regions that have achieved creditworthiness, opportunities exist for fee-for-service activities or sub-national lending without sovereign guarantees. - Discussions on new instruments will give particular attention to facilitating Bank work in poorer areas. *Source: _cr09246 - 8. In addition to continued general cooperation with the federal government, the Bank — https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09246.pdf* ### ANNEX III. RUSSIAN FEDERATION—STATISTICAL ISSUES APPENDIX ### ANNEX III. RUSSIAN FEDERATION—STATISTICAL ISSUES APPENDIX ### I. Assessment of Data Adequacy for Surveillance - General: - Data provision has some shortcomings, but is broadly adequate for surveillance. - Weaknesses identified in government finance statistics, external debt statistics, and in terms of data accuracy. - National Accounts: - Source data obtained from surveys of businesses and households, supplemented by administrative data. - Inadequate reporting by firms has constrained improvement of the national accounts. - Lack of balance sheet data impedes analysis of balance sheet vulnerabilities. - A TA mission (November 2008) noted Rosstat generally follows 1993 SNA, but: - Imputed rental services of owner-occupied dwellings are clearly undervalued. - Methodological improvements needed in volume measures of production-based GDP estimates, including FISIM (financial intermediation services indirectly measured). - Price statistics: - Data broadly adequate for surveillance; detailed CPI component time series analysis is difficult due to lack of accurate time series data on CPI weights. - Monthly CPI and PPI, both Laspeyres indices (2000=100), cover all regions. - Rosstat publishes indices for foodstuffs, non-food products, and services. - CPI component weights available since 2006; PPI components are not disclosed. - Consumer spending data used to calculate the CPI are posted annually; in 2009 the basic structure of household consumer expenditures underlying CPI calculations was made available on the website. - Improvements suggested: treatment of seasonal items in core inflation index; a new household budget survey. - Government finance statistics: - Timeliness and quality could be improved. - Domestic and external federal debt compiled monthly, made public only in summary form quarterly. - No unified debt monitoring and reporting system. - Published functional classification of expenditure differs slightly from international standards; economic classification data available with considerable lag. - Lack of timely economic classification data hampers assessment of transfers to the general public and channels through which government expenditure affects national accounts. - Ongoing improvements under a work program with STA, but scope remains to improve expenditure data. - Monetary statistics: - TA mission (April 2007) assisted expanding coverage to other (nondepository) financial corporations and completion of SRFs; mission recommended reconsidering compiling data in full accordance with the SRFs framework. - Since July 2008, Bank of Russia submits summarized data on: Central Bank Survey; Other Depository Corporations Survey; Depository Corporations Survey; Other Financial Corporation Survey; Financial Corporations Survey. - During the global turmoil, analysis of balance sheet effects hindered by lack of consistent currency and maturity breakdowns of banking-sector assets and liabilities. - Balance of payments: - Broadly adequate for surveillance with significant improvements, but scope remains to improve coverage of certain current, capital, and financial account components. - Need more detailed supplemental data on the financial account to analyze complex flows (e.g., gross flows of long-term external debt for banks are not available). - Reliance on partial data from various sources necessitates estimates and adjustments; CBR adjusts merchandise import data from State Customs Service to account for “shuttle trade,” smuggling, and undervaluation. - Russian compilers seek reconciliation with partner-country data. - Improvements in coverage and quality of direct investment surveys; CBR intends to participate in the Coordinated Direct Investment Survey. - Headline reserves reported weekly with a four-business day lag; Reserve Template disseminated with a lag of twenty days and is more comprehensive than central bank balance sheet detail provided to the Fund. ### II. Data Standards and Quality - SDDS participation: - Participant in the Special Data Dissemination Standard (SDDS) since January 31, 2005. - Data ROSC: - A data ROSC prepared in October 2003 was published on the IMF website on May 14, 2004. ### III. Reporting to STA (Optional) - Data reported for publication in: - International Financial Statistics (IFS) - Government Finance Statistics Yearbook - Direction of Trade Statistics - Balance of Payments Statistics Yearbook ### Table of Common Indicators Required for Surveillance (As of May 31, 2009) — Selected entries - Exchange Rates: - Date of latest observation: 5/12/2009; Date received: 5/12/2009; Frequency of data: D; Frequency of reporting: D; Frequency of publication: D - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: - Date of latest observation: 5/1/09; Date received: 5/8/09; Frequency: W; Frequency of reporting: W; Frequency of publication: W - Reserve/Base Money (narrow definition): - Date of latest observation: 5/4/09; Date received: 5/8/09; Frequency of data: D; Frequency of reporting: W; Frequency of publication: W - Reserve/Base Money (broad definition): - Date of latest observation: 5/4/09; Date received: 5/8/09; Frequency of data: D; Frequency of reporting: M; Frequency of publication: M - Broad Money: - Latest observation: March 2009; Date received: 4/28/09; Frequency: M; Frequency of reporting: M; Frequency of publication: M - Central Bank Balance Sheet: - Latest observation: April 2009; Date received: 5/4/09; Frequency: M; Frequency of reporting: M; Frequency of publication: M - Consolidated Balance Sheet of the Banking System: - Latest observation: March 2009; Date received: 5/5/09; Frequency: M; Frequency of reporting: M; Frequency of publication: M - Consumer Price Index: - Latest observation: April. 2009; Date received: 5/5/2009; Frequency: M; Frequency of reporting: M; Frequency of publication: M - Revenue, Expenditure, Balance and Composition of Financing — General Government: - Latest observation: April, 2009; Date received: 5/12/2009; Frequency: M; Frequency of reporting: M; Frequency of publication: M - External Current Account Balance: - Latest observation: Q1 2009; Date received: 4/3/2009; Frequency: Q; Frequency of reporting: Q; Frequency of publication: Q - GDP/GNP: - Latest observation: Q4 2008; Date received: 4/2/2009; Frequency: Q; Frequency of reporting: Q; Frequency of publication: Q - Gross External Debt: - Latest observation: Q1 2009; Date received: 4/7/2009; Frequency: Q; Frequency of reporting: Q; Frequency of publication: NA - International Investment Position: - Latest observation: 2008; Date received: 7/1/2009; Frequency: A; Frequency of reporting: A; Frequency of publication: A ### Background, Outlook, and Policy Findings (IMF Article IV, July 27, 2009) - Background and shocks: - Russia hit by dual shocks: a collapse in oil prices and a sudden reversal of capital flows. - Fixed investment plummeted; real GDP contracted sharply in the first quarter; labor market conditions eased, dampening growth in real wages. - Output gap widened and inflation pressures eased. - After an initial sharp depreciation, modest increase in oil prices and renewed capital inflows provided some support to the ruble, which remains broadly in equilibrium. - Banking sector and credit: - Banking system under increasing strain; private sector credit contracting. - Level of overdue loans has more than doubled since January, despite regulatory forbearance. - Banks displayed a strong preference for liquidity. - Since monetary policy was abruptly tightened in January, stock of credit has been falling (first time since end-2004). - Policy response: - Authorities provided significant liquidity at low interest rates and kept the exchange rate stable initially to offset loss of foreign financing. - Reserve losses and capital outflows led to a ruble devaluation and monetary tightening; subsequently monetary policy gradually eased as exchange rate stabilized and oil prices ticked up. - April 2009 supplementary budget included large discretionary increases in defense and security spending and anti-crisis measures (tax reductions, support to strategic sectors, enhanced social assistance). - Non-oil deficit of the general government expected to widen by 5½ percent of GDP in 2009—reaching 13¾ percent of GDP. - Deficit to be monetized by drawing down the Oil Reserve Fund, except for domestic borrowing of up to 1 percent of GDP. - Outlook and risks: - Real GDP expected to contract by 6½ percent in 2009. - Economy projected to recover only slowly in 2010; inflation gradually falling. - Current account surplus to decline in 2009 before modest improvement in 2010 as oil prices recover. - Taking into account planned monetization of the fiscal deficit, capital outflows expected to remain relatively high at $68 billion. - External environment risks: subdued global growth, gradual recovery in commodity prices, global deleveraging limiting capital inflows. - Executive Board assessment and recommendations: - Directors commended authorities for swift and substantial response but noted macroeconomic management has been challenging; economic activity projected to decline sharply in 2009 and recover only gradually in 2010. - Stabilization of the banking sector is immediate but complex; regulatory forbearance has impaired accurate asset quality assessment. - Directors recommended: - Mandatory, bottom-up stress tests of larger banks embedded in a holistic banking-sector risk analysis. - A roadmap outlining supervisory responses if a bank’s capital deteriorates. - Strengthening the supervisory authority of the Central Bank of Russia (CBR). - Scaling back the fiscal stimulus and reorienting its composition toward measures that are self-reversing, due to concern that the large stimulus may become entrenched and lead to excessive real appreciation and lower competitiveness. - Continuing cautious monetary easing given declining inflation, considering potential impact on the ruble and plans to transition to an inflation targeting regime. - CBR should stand ready to support the ruble if unexpected developments unsettle exchange rate expectations; interventions should be temporary and the exchange rate should ultimately reflect fundamentals. - Greater exchange rate flexibility to help limit speculative capital flows and signal a credible commitment to price stability. - Directors welcomed plans to reinvigorate structural reforms in health and education, regretted delays in other reforms critical to investment climate and diversification, and noted concerns about momentum toward WTO accession. ### Selected Macroeconomic Indicators, 2006–10 (selected rows; values preserved) - Real GDP (Annual percent change): - 2006: 7.7 - 2007: 8.1 - 2008: 5.6 - 2009: -6.5 - 2010 Proj.: 1.5 - Consumer prices (Period average): - 2006: 9.7 - 2007: 9.0 - 2008: 14.1 - 2009: 12.3 - 2010 Proj.: 9.9 - Consumer prices (End of period): - 2006: 9.0 - 2007: 11.9 - 2008: 13.3 - 2009: 11.0 - 2010 Proj.: 9.0 - GDP deflator: - 2006: 15.5 - 2007: 13.9 - 2008: 19.2 - 2009: 4.0 - 2010 Proj.: 13.6 - General government overall balance (Percent of GDP): - 2006: 8.3 - 2007: 6.8 - 2008: 4.3 - 2009: -5.4 - 2010 Proj.: -5.0 - General government revenue (Percent of GDP): - 2006: 39.5 - 2007: 40.0 - 2008: 38.4 - 2009: 33.9 - 2010 Proj.: 35.3 - General government expenditures (Percent of GDP): - 2006: 31.2 - 2007: 33.2 - 2008: 34.1 - 2009: 39.3 - 2010 Proj.: 40.2 - Non-oil balance (Percent of GDP): - 2006: -4.5 - 2007: -3.9 - 2008: -8.3 - 2009: -13.8 - 2010 Proj.: -14.7 - Federal government overall balance (Percent of GDP): - 2006: 7.4 - 2007: 6.2 - 2008: 3.5 - 2009: -5.5 - 2010 Proj.: -5.0 - Money: Base money (Annual percent change): - 2006: 39.6 - 2007: 33.1 - 2008: 2.9 - 2009: 4.1 - 2010 Proj.: 16.7 - Ruble broad money (Annual percent change): - 2006: 48.8 - 2007: 47.5 - 2008: 1.7 - 2009: 4.8 - 2010 Proj.: 21.5 - External current account (Billions of U.S. dollars): - 2006: 94.3 - 2007: 76.2 - 2008: 102.3 - 2009: 18.3 - 2010 Proj.: 38.9 - External current account (percent of GDP): - 2006: 9.5 - 2007: 5.9 - 2008: 6.1 - 2009: 1.5 - 2010 Proj.: 2.9 - Gross international reserves (Billions of U.S. dollars): - 2006: 303.7 - 2007: 478.8 - 2008: 427.1 - 2009: 375.7 - 2010 Proj.: 397.2 - Months of imports (billions of U.S. dollars; months of imports of goods and non-factor services): - 2006: 17.4 - 2007: 20.3 - 2008: 13.9 - 2009: 18.0 - 2010 Proj.: 18.2 - Percent of short-term debt: - 2006: 212 - 2007: 204 - 2008: 364 - 2009: 285 - 2010 Proj.: 285 - Memorandum items: - Nominal GDP (billions of U.S. dollars): 2006: 989; 2007: 1,294; 2008: 1,677; 2009: 1,208; 2010 Proj.: 1,329 - Exchange rate (rubles per U.S. dollar, period average): 2006: 27.2; 2007: 25.6; 2008: 24.9 - World oil price (U.S. dollars per barrel, WEO): 2006: 64.3; 2007: 71.1; 2008: 97.0; 2009: 60.5; 2010 Proj.: 74.5 *Source: ANNEX III. RUSSIAN FEDERATION—STATISTICAL ISSUES APPENDIX (as of May 2009) and IMF Public Information Notice No. 09/99, July 27, 2009.* ### 1. This statement contains information that has become available since the Staff Report ### _cr09246 - 1. This statement contains information that has become available since the Staff Report ### Recent Developments - The statement updates information made available since the Staff Report circulated to the Executive Board on July 14, 2009, and does not alter the thrust of the staff appraisal. - First-quarter 2009 dynamics: - Investment collapsed and consumption declined abruptly. - A parallel drop in imports partially offset the decline. - A sharp drawdown of inventories accounted for 8½ percentage points of a total GDP decline of 9¾ percent (y/y). - Second-quarter signals: - High-frequency data suggest continued weakness in activity despite increased government spending. - CPI inflation was 11.9 percent (y/y) in June. - Near-term expectations: firms are expected to start rebuilding inventories; there are reports this process may have begun. - June data suggest industrial production and investment have stabilized, and the rate of contraction of consumption appears to be moderating. - Staff assessment: the economy is expected to experience only a gradual recovery after the very deep drop in output in the first quarter. ### Exchange-rate volatility and monetary policy - Recent exchange-rate volatility highlights the need for a cautious approach to interest-rate policy. - Central Bank of Russia (CBR) actions: - In the context of a buildup of bank deposits with the central bank, the CBR cut policy interest rates by 50 bps on July 13. - The cumulative drop since mid-April was 200 bps. - The cut coincided with a fall in world oil prices, triggering a sudden ruble depreciation of about 3½ percent and a loss of reserves of around $3–4 billion. - The CBR issued its first ever statement explaining its decision to reduce interest rates as part of improved communication on monetary policy. - Subsequent developments: - Oil prices improved and the exchange rate strengthened after the depreciation episode. - The banking system continues to prefer liquidity over new lending. - The short-term carry trade remains an important source of foreign inflows. - Concerns about the currency’s fragility persist. ### Bank Recapitalization - Authorities are finalizing a banking system recapitalization plan. - A law outlining key points of the recapitalization plan has been signed by the President; detailed parameters remain under discussion among relevant government institutions. - Broad plan details: - Issue government securities (OFZ) equivalent to Rub 150 billion in 2009 and Rub 310 billion in 2010. - The OFZs would be exchanged with banks in return for preferred shares, which would count as Tier 1 capital. - The objective is to restore credit growth as soon as possible, focusing on sound banks. - Treatment of banks with severe capital shortfalls: - These will be addressed via the Deposit Insurance Agency’s (DIA) bank-resolution framework. - The DIA currently has 18 banks under rehabilitation. - The DIA still has undisbursed funds available from an initial Rub 200 billion budget allocation earlier in the year. - The authorities do not expect the DIA will require further funding for this purpose. ### Fiscal Policy - Fiscal stimulus timing: - Recent data suggest fiscal stimulus came on stream toward the end of the second quarter. - The non-oil deficit in the second quarter widened to 3¼ percent of GDP compared with about 1 percent of GDP during the same period last year. - Budget planning: - Authorities are formulating fiscal policies for 2010 and the medium term. - Preliminary information indicates they are likely to base the medium-term budget on lower oil price and growth assumptions—and thus lower revenue projections—than those used by staff, implying still-high overall and non-oil deficits. - The process remains at an early stage, with macroeconomic assumptions and revenue and expenditure projections still being refined. *Source: IMF staff statement updating information available since the Staff Report circulated on July 14, 2009.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09246.pdf_