The macroeconomic environment continues to be favorable, with strong GDP growth, moderate inflation and large current account and fiscal surpluses. The oil-driven boom is, however, leading to growing macroeconomic tensions. While the near-term outlook is strong, based on current projections for oil prices, and external vulnerabilities are generally low, recent nervousness in the banking sector and uncertainty related to the Yukos affair highlight the fragility of confidence.
GDP growth rose to 7–7½ percent in 2003 and the first half of 2004, and became better balanced. The acceleration was mainly due to higher investment, but also to increased oil export volumes. Growth continued to depend heavily on the favorable external environment, in particular high oil prices, but recent increases in investment were also related to political stability, generally sound macroeconomic policies, and some structural reforms, suggesting that GDP is increasingly deriving strength from domestic factors as well.
Macroeconomic tensions have increased, however, as growth has risen and the balance of payments strengthened. While headline inflation declined to 12 percent at end-2003 and further during the first half of 2004, this was mainly due to administered price restraint; core inflation has become entrenched at 10–11 percent over the past two years. Tightening labor markets have added to inflationary pressures. With inflation still high relative to competitors and the ruble broadly stable in nominal effective terms, the pace of real ruble appreciation has increased to nearly 10 percent over the past year.
The balance of payments has strengthened further. Despite higher imports related to rapid demand growth and real appreciation, the external current account surplus has remained at 8-9 percent of GDP during the past two years, supported by high world commodity prices. Meanwhile, net private capital outflows declined substantially in 2003, reflecting higher corporate and banking sector borrowing as well as some reversal of foreign currency substitution. In the first half of 2004, net outflows increased, with volatility reflecting periodic uncertainty linked to the Yukos affair, prospects for global interest rates, and perceived changes in the central bank’s intervention and exchange rate strategy. Nonetheless, reserves accumulation continued, even as the banking system was hit by turmoil in July. Gross international reserves stood at about $88.5 billion (over seven months of imports) at end-July. Public external debt, net of reserves, has fallen close to zero, compared with $140 billion in 1998.
The Central Bank of Russia (CBR) has intervened heavily to slow ruble appreciation over the past 18 months. The interventions were largely unsterilized, causing a surge in money growth during 2003. Rapid broad money growth, partly reflecting conversion of cash foreign currency holdings into ruble deposits, fuelled growth in credit to the economy of around 44 percent in the year to June 2004.
The trend toward fiscal relaxation is continuing, notwithstanding some tightening in the 2004 budget. Despite higher oil prices and strong economic growth, the general government surplus increased by only ½ percent of GDP, to 1 percent of GDP, in 2003. This represents an underlying loosening of the fiscal stance at constant oil prices of about 1 percent of GDP. The 2004 budget envisions a moderate tightening, to be achieved through postponement of non-interest expenditure increases, but plans for the 2005 budget suggest that this will be reversed, in response to growing pressures to spend more of the oil revenue windfall on tax cuts and expenditure reforms.
Progress on structural reform has been limited. The two major reforms in 2003 relate to the financial system. The law on foreign exchange regulation introduced a far-reaching liberalization of capital flows. It allows the imposition of unremunerated deposit requirements on capital flows, and the CBR decided to introduce such requirements from August 2004. Additionally, legislation was passed to introduce mandatory insurance of household deposits.
Increased regulatory vigilance in recent months has triggered nervousness in the private banking sector. The CBR has begun to assess applications by banks for entry into the deposit insurance system and has strengthened enforcement of prudential standards and Anti-Money Laundering/Combating Financing of Terrorism (AML/CFT) legislation. Confidence was shaken when the CBR withdrew the license of a bank in May 2004 for AML/CFT violations, leading to a liquidity squeeze and deposit runs at some banks. Although the situation has since calmed down, reflecting prompt actions by the CBR, confidence remains fragile.
Executive Board Assessment
Directors commended the authorities’ good management of the economy, and the strengthening of GDP growth and the balance of payments, driven by high oil prices, increasing oil export volumes, and strong domestic demand. They were pleased that growth was becoming broader based and better balanced, and that key social indicators were improving. However, Directors advised that, with a buoyant economy, fiscal policies should not be eased and monetary policy should focus more on controlling inflation than on resisting nominal appreciation. To maintain competitiveness and diversify the economy, they also saw a need to invigorate the pace of structural reforms.
Given the strong oil price outlook, and Russia’s large international reserves and low public debt, Directors expected that growth would remain robust over the near term and that external vulnerabilities would likely remain low. They cautioned, however, that further turmoil in the banking system could damage confidence.
Directors commended the achievement of a fiscal surplus in recent years and the establishment of an oil stabilization fund. They cautioned, however, that fiscal policy should not provide additional stimulus at this point in the economic cycle, and viewed the authorities’ plans to relax fiscal policy in 2005 as exacerbating pressures for real ruble appreciation, arising from the exceptionally strong balance of payments, and increasing inflationary pressures. They recommended increasing the cap on the collection of windfall oil revenues in the oil stabilization fund and considering the use of some revenues in the fund to reduce debt. Directors recognized, however that, once cyclical pressures eased, there could be a case for spending more on carefully elaborated long-term fiscal structural reforms, including on health care and pension reform, and on public infrastructure. They welcomed the authorities’ plans to restructure and monetize the system of in-kind benefits, and to judiciously reduce the social tax rate, accompanied by any necessary measures to ensure achievement of the broader fiscal objectives. They concurred on the importance of further development of regional and local fiscal capacity.
Directors agreed that the central bank needed to clarify the two competing objectives of controlling inflation and managing the exchange rate. They highlighted their concern over the emphasis on stemming real ruble appreciation, because, in their view, monetary policy could not target the real exchange rate, except in the short run, and the efforts to resist appreciation had resulted in inflation becoming entrenched at a relatively high level. Most Directors felt that the cost to the economy of high inflation was not sufficiently recognized, while the cost of ruble appreciation was exaggerated. They urged the central bank to allow more nominal exchange rate flexibility, to facilitate a reduction of interest spreads and discourage speculative capital inflows, and to take advantage of the disinflationary impact of nominal appreciation. They also highlighted the need to strengthen the independence of the central bank.
Directors welcomed steps to liberalize the capital account. Most Directors saw unremunerated deposit requirements as, at best, a temporary measure to stem capital inflows and advised the authorities to consider the experience of other countries where such requirements have raised the cost of capital, especially for small-and medium-sized enterprises. It was felt that deposit requirements could help limit large inflows of volatile short-term capital to weak banks. However, Directors took the view that deposit requirements should be temporary, reserved to deal with exceptionally large and volatile inflows, and should not be used to stem sustained pressure for ruble appreciation.
Directors stressed that recent turmoil in the banking sector demonstrated the urgency of strengthening prudential supervision and crisis management tools, while pressing ahead with closing unsound banks. They commended the central bank for taking prompt actions to calm the situation, including halving reserve requirements and extending interim household deposit insurance to all banks. However, they noted that extension of deposit insurance could increase moral hazard, and encouraged the central bank to be unwavering in enforcing sound prudential standards. Directors urged the authorities to give the central bank strong political support and facilitate the development of more effective instruments for further strengthening banking supervision and weeding out problem banks. In this regard, Directors welcomed the prompt action by the Duma to strengthen the bank bankruptcy law. They also encouraged further development of a private banking sector and stronger action to counter money laundering.
Directors noted that the authorities’ structural reform plans were well focused and progress had been made in some areas, including pension reform. However they thought that these plans would benefit from more emphasis on specifics, as overall implementation had slowed. They encouraged the authorities not to view high oil prices and strong growth as grounds for complacency but, rather, as a unique opportunity to carry out the structural reforms needed to sustain growth over the medium term. They emphasized the importance of diversifying the economy and reducing reliance on natural resources, and in this regard, welcomed the priority given to encouraging domestic and foreign direct investment and improving the investment climate for small- and medium-sized enterprises. They also supported the focus on public administration reform, banking reform, and housing reform, and underscored the benefits of liberalizing trade and early WTO accession. They underscored the need to improve governance and the rule of law, and to resolve successfully the Yukos affair. They also emphasized the importance of reforming the energy sector, breaking up inefficient monopolies, and improving labor market flexibility.
Directors welcomed the findings of recently conducted Reports on the Observance of Standards and Codes modules on data and fiscal transparency, and the authorities’ decision to publish these reports. They noted that Russia’s statistical database is mostly adequate for surveillance and that dissemination practices meet most of the Special Data Dissemination Standard requirements, and welcomed the authorities’ intention to subscribe to the SDDS. They also commended the progress made in strengthening fiscal transparency and financial management.
Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
|Production and prices||(Annual percent change)|
|End of period||18.6||15.1||12.0||10.0|
|Public sector||(In percent of GDP)|
|General government overall balance 1/||2.7||0.6||1.1||3.1|
|Federal government overall balance 1/||2.7||1.3||1.5||3.0|
|External sector||(In billions of U.S. dollars)|
|External current account (deficit -)||33||31||36||47|
|Stock of public external debt||112||103||94||88|
|Gross reserves coverage (in months of imports of GNFS)||5.0||5.6||7.1||7.6|
|Nominal GDP (in billions of rubles)||8,944||10,834||13,285||16,090|
|Exchange rate (rubles per U.S. dollar, period average)||29.2||31.3||30.7||…|
|Russian oil price (U.S. dollars per barrel, c.i.f.)||22.9||23.6||27.3||30.1|
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. This PIN summarizes the views of the Executive Board as expressed during the Executive Board discussion based on the staff report.