Russian Federation: Staff Concluding Statement of the 2017 Article IV Mission

IMF News, May 19, 2017

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The economy is exiting a two-year recession that, thanks to the authorities’ effective policy response and the existence of robust buffers, proved shallower than past downturns.
Growth is expected to reach 1.4 percent this year, supported by easier financial conditions and higher oil prices.
Inflation continues to decline, driven by the ruble appreciation and still weak consumer demand, and is forecasted to reach the Central Bank’s 4 percent target this year and to remain close to it thereafter.
Short-term risks from volatile financial markets and oil prices have diminished.
Medium-term growth will be subdued, at about 1½ percent, due to structural bottlenecks (e.g., demographic, technological) and the lingering effects of sanctions that restrain the potential to increase investment.
Four key policy priorities identified:
- introducing a fiscal rule that anchors consolidation and generates sufficient savings;
- reaching the 4 percent inflation target while continuing gradual monetary policy easing;
- pursuing financial sector reforms to foster financial deepening and support growth;
- advancing decisive structural reforms to improve growth potential and rebalance growth towards non-commodity sectors.

The reinstatement of the three-year budget framework in the 2017-2019 federal budget is welcomed to reduce policy uncertainty.
The pace of deficit reduction in the three-year budget is appropriate, capitalizing on the recovery, to allow a steady adjustment reflecting the reality of permanently lower oil prices.
Recommendations and observations:
- More permanent and better targeted measures should be envisaged, including to safeguard growth-enhancing fiscal spending.
- The purchase of foreign currency using the mechanism unveiled by the Ministry of Finance in February improves predictability of fiscal policy while cushioning, and eventually replenishing, fiscal buffers.
- This mechanism cannot substitute for a fiscal rule that anchors fiscal adjustment.
- In designing a new fiscal rule, consider targeting a higher level of savings to secure intergenerational equity and introduce a mechanism allowing for a smooth adjustment to persistent oil price changes.

Monetary policy easing initiated in March was appropriate considering the inflation outlook and the decline in inflation expectations.
Policy guidance:
- Interest rate cuts should continue at a gradual pace given the uncertain size of the output gap, the volatility of oil prices, and the potential reversal of the exchange-rate-driven disinflation.
- The Central Bank’s communication regarding prospects for meeting the inflation target should shift to a horizon beyond end-2017 by elaborating a medium-term inflation targeting framework.

Banks are now in a better position to support the recovery with better financing conditions and improved capital buffers.
Authorities have increased banking system resilience by:
- setting limits on related-party lending;
- gradually reducing dollarization through macroprudential measures;
- introducing a tiered supervisory framework.
Recommended actions to enhance the supervisory and resolution framework:
- Accelerate the introduction of explicit early bank intervention procedures.
- Ensure the new resolution mechanism shortens the process of open bank resolution and reduces balance sheet encumbrance.
- Remove obstacles to effective use of purchase and assumption (P&A) transactions.
- Replace central bank funding by federal government funds where appropriate.
- Increase recourse to banking industry capital.
- Continue work on statutory bail-in legislation that factors in financial stability implications.
Strengthen the effectiveness of the AML/CFT framework, including measures related to politically exposed persons and entity transparency, to address financial crimes related to tax evasion and corruption.

Structural reforms are required to lift potential output and accelerate convergence towards per capita income levels of advanced economies.
Despite a more competitive exchange rate, non-traditional sectors have not responded robustly and a new less commodity-dependent growth model has not yet emerged.
Authorities have undertaken measures such as passing a PPP law, privatizing some state-owned companies, and purging weak banks, but a wider reform agenda is needed to:
- jump start investment;
- support reallocation of factors of production from the non-tradable to the tradable sectors;
- increase productivity.
Priority reform areas: property rights, governance, labor market policies, innovation, and infrastructure.
Urgent need to understand and measure how the large size of the state may hamper economic performance, to better focus state activity where it yields positive spillovers for productivity and competition, including at the regional level.
Given weak penetration of foreign markets by Russian companies and the need to integrate into global value chains, authorities should actively seek to expand the scope and number of their preferential trade agreements.
Pension reform, such as increasing the statutory retirement age, could help ease negative demographic trends on labor markets.
An appropriately designed fiscal rule would help shield competitiveness by dampening the impact of volatile oil prices on the exchange rate.

Russian Federation: Staff Concluding Statement of the 2017 Article IV Mission (May 19, 2017).