Worker checking the valve of an oil pipe in West Siberia, Russia. The country should continue its adjustment, says the IMF (Sergei Karpukhin/ Reuters/Newscom)

Russia: Adjusting to Lower Oil Prices

July 13, 2016

  • Policy cushioned oil price and sanctions shock
  • Economy still in recession, but growth should resume in 2017 
  • Banking system crisis was averted, but recovery will be slow 

After a contraction of its economy in 2015 due to a decline in oil prices, and sanctions, the Russian economy remains in a recession this year, but there are prospects for a modest recovery in 2017.

IMF Survey talked about the state of the Russian economy with Ernesto Ramirez Rigo, Mission Chief for the annual Article IV review of Russia, and Karl Habermeier, Mission Chief for Russia’s financial stability assessment report, issued about systemically important economies in each five years.

IMF Survey: What are the near-term prospects for Russia’s economy? Has the recovery began?

Ramirez Rigo : Russia still faces a difficult period ahead, as oil prices are still low and as the authorities continue with the needed fiscal adjustment. We expect the economy to contract by around 1.2 percent this year, but we foresee some recovery with growth of around one percent in 2017. Inflation should continue to decline, falling to about 5 percent by 2017.

What is very difficult to tell at this point is whether Russia has already reached the recovery phase. It is clear that the contraction in economic activity has slowed, and there are some sectors of the economy that are showing signs of positive improvements, especially the areas benefitting from the currency depreciation like the agro industry. Other sectors benefiting from the more competitive exchange rate include plastics, some pharmaceutical companies, and petro-chemical industries. Unfortunately, these positive signs are not widespread enough, and a big rebound in economic activity remains unlikely with depressed oil prices and until more investment takes hold in other manufacturing and service sectors.

IMF Survey: What does Russia need to do to provide a foundation for stronger long-term growth?

Ramirez Rigo: Russia can now use the more competitive exchange rate to its benefit. However, in itself the change in relative prices might not be sufficient without structural reforms. There is a hoist of such reforms that the authorities have correctly identified and took up in the past, yet there has been little prioritization and persistence in their implementation. We think that reforms around the institutional framework including contract enforcement and resolution of private-public disputes are important.

There are also things that need to be done to increase the efficiency of the goods market and competition which has been stifled because of the large footprint of the state in the economy.

And then one critical thing where Russia seems to be lagging is trade integration: Russian firms should have access to a much larger set of markets than the domestic ones or those accessible under the Eurasian Economic Union.

IMF Survey: What is staff advice on monetary and fiscal policy?

Ramirez Rigo: Well, on the fiscal side it is clear that with the price of oil expected to remain low for quite a while, there is a need for a significant adjustment of public finances to put them on a sustainable path. In 2016, the authorities implemented a very bold adjustment. But there is more adjustment to be done in the medium term, and we think that its planning in a multi-year framework would have more credibility and would reduce uncertainty. One of its cornerstones, the fiscal rule – which makes government spending contingent on the long-term average oil price - needs a revision to allow the government to react more flexibly to changes in oil prices.

The recommended adjustment should strive to preserve spending areas which contribute to growth such as education, health care and the like.

In monetary policy, we’ve seen a very successful transition under very difficult circumstances to inflation targeting. The monetary authorities have achieved remarkable results in a very short period of time, bringing inflation from double digits in 2015 to an expected 6.5 percent at the end of this year. At the same time, with relatively weak labor market conditions, thus low wage pressures, and weak consumption which holds back inflation, we think that there is a scope for more monetary policy normalization. External pressures are lower, for example Russian external debt decreased rapidly. This cut the risk of further depreciation and thus rising inflation.

IMF Survey : The financial stability analysis says that the financial sector is stable but should be strengthened. What needs to be done?

Habermeier: First of all, the banking sector was already under strain due to weak growth and structural factors before the onset of the current economic turbulence in late 2014. These conditions manifested quite strongly during the crisis. The authorities were able to stabilize the banking sector through a very decisive response which involved providing emergency liquidity, injecting capital, and some temporary regulatory forbearance.

A full blown financial crisis was thus averted, but looking at the financial position of banks, we can see that non-performing loans are rising quite significantly, and the capital position of banks needs to be strengthened. One of our recommendations in the financial stability assessment was to conduct a systematic asset quality review to get a better picture of what needs to be done in the field of additional bank capitalization. Such a review should be supported by a stronger stress testing.

The process of cleaning the banking system has to continue. The Central Bank of Russia has been withdrawing licenses from weak banks at a quite a rapid pace. But not all internationally recommended tools for resolving banks are currently available. So another important action is to establish a complete set of instruments for bank resolution.

IMF Survey: State banks play a very large role in the financial sector. Is this a problem?

Habermeier: State banks play a significant part in the banking systems of many emerging market countries, including India and China. State ownership is often considered to be a weakness in that banks lend at the behest of the government. In Russia, this is not such a big problem because the largest state banks with the most significant market share actually have been put on a commercial footing, and, as a result, operate pretty much like private commercial banks. They are also listed and, in fact, have private and indeed foreign shareholders. For example, in the largest bank, Sberbank, the government only holds 50 percent plus one share at the moment.

One feature that requires attention is the dual role of the Central Bank of Russia: it is both the supervisor and the owner of Sberbank. This arrangement has functioned reasonably well given the commercial orientation of Sberbank and the fact that the Central Bank has very carefully balanced its dual roles. But it may still impede the longer-run transition to a more market-oriented and competitive banking system.

Another issue is that generally speaking the ownership of state-owned banks is dispersed among different government agencies. This has made it more difficult to implement some of the necessary governance reforms, such as having independent directors, and stronger public disclosure and transparency.

The last point on state banks is that many are systematically important institutions, and are perceived to have an implicit government guarantee. Therefore, when people had doubts about some of the other banks, they were able to transfer deposits into the state banks considered safe havens. That was overall a stabilizing factor.