Russian Federation: Staff Concluding Statement of the 2018 Article IV Mission

IMF News, May 23, 2018

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The Russian economy is recovering from a two-year recession.
Russia’s convergence to advanced economy income levels has stalled and its weight in the global economy is shrinking.
The medium-term outlook remains weak despite the ongoing recovery.
With the projected growth rates, the country would lag behind peers in Eastern Europe and convergence with advanced economies would not take place.
Factors constraining growth: insufficient infrastructure; an aging population; a large footprint of the state; governance and institutional weaknesses that increase economic concentration and stifle dynamism; slow integration in the global economy; uncertainty due to geopolitical tensions negatively affecting private investment.

Authorities have implemented a strong macroeconomic policy framework: a prudent fiscal rule, inflation targeting, and a flexible exchange rate.
The fiscal rule has helped anchor the fiscal path and shield the economy from disruptive swings in oil prices.
Inflation is below the 4 percent target and the output gap is closing.
The current monetary stance is described as moderately tight, especially given ongoing fiscal consolidation.

The recovery in oil prices should not delay fiscal adjustment or a growth-friendly shift in the budget.
The authorities should resist revising the fiscal rule as this could undermine credibility.
The pace of adjustment over 2018-20 is appropriate, but its quality could be improved since it relies excessively on across-the-board spending freezes which are suboptimal and unsustainable.
Further consolidation of 1-2 percent of GDP is needed over the medium term to reach a fiscal balance consistent with sharing Russia’s natural resources with future generations.
Options to finance higher spending on health, education, and infrastructure within the fiscal rule:
- Re-prioritize other spending.
- Strengthen tax compliance.
- Broaden the tax base by reducing tax expenditures under VAT and PIT.
- Consider parametric pension reform to provide fiscal space.
Social assistance is high but too broadly and thinly spread; better targeting is needed to meaningfully reduce poverty.

With inflation below the 4 percent target and a closing output gap, a continued transition to a neutral monetary policy stance is appropriate.
The CBR should maintain a gradual and data-driven approach, as inflation expectations are not yet firmly anchored and external and fiscal risks have increased.
The central bank should continue refining its communication strategy to strengthen credibility and reduce inertia in the formation of inflation expectations.

Last year’s failure of several large private banks expanded the state’s footprint in the sector and placed a non-negligible burden on public finances.
These failures highlighted shortcomings: excessive risk concentration and lending to connected parties rather than to the most competitive firms.
Policy recommendations:
- Renew efforts to close gaps in bank supervision and regulation.
- Improve the provision of accurate financial statements.
- Intensify supervision of risks, with a focus on related-party lending.
- Swiftly complete elements of asset quality reviews and ensure their transparency, credibility, and alignment with best international practices.
- Strengthen ex post communication of the Central Bank of Russia’s rationale behind bank resolution decisions.
- Develop a credible strategy for returning rehabilitated banks to private hands consistent with increasing competition and improving capital allocation.

Boosting growth requires stronger competition in domestic markets, a leaner state, and a more vibrant private sector.
The footprint of the state is estimated at around a third of the economy and needs to be reduced, particularly in banking and other sectors with limited rationale for public ownership.
Sequencing is critical: first strengthen institutional architecture to avoid further concentration of economic power after privatization.
Specific reform directions:
- Enhance competition, including by facilitating entry/exit.
- Use state purchases to promote market contestability and the development of SMEs.
- Strengthen transparency, accountability, and governance standards in the corporate sector, particularly for SOEs, to raise efficiency in the use of state resources.
- Persist with efforts to strengthen competitiveness, promote trade integration, and diversify exports.

Authorities’ plans to boost spending on health, education, and infrastructure are welcomed but should not compromise the credibility of the fiscal rule.
A well-designed and deficit-neutral shift from social security to consumption taxes could:
- Incentivize labor supply.
- Reduce labor informality.
- Attract new investment.
Long-delayed parametric pension reform could help offset negative demographic trends at least temporarily.

The IMF team thanks the authorities and other interlocutors in the public and private sectors for their cooperation, open and constructive discussions, and warm hospitality.

Russian Federation: Staff Concluding Statement of the 2018 Article IV Mission, May 23, 2018.