Abstract
The staff report for the 2007 Article IV Consultation highlights the Russian Federation’s long-term perspective, economic developments, and macroeconomic policies. Russia’s economic growth remains robust. High oil prices and sound fiscal policy underlie Russia’s long spell of robust growth. Executive Directors noted that Russia continues to face tensions in the policy mix designed to reduce inflation while preserving exchange rate stability. Raising investment levels is particularly important in light of the projected decline in the labor force and the declining prospect for continued high productivity gains over the medium term.
1. This statement summarizes information that has become available since the staff report was issued. The thrust of the staff appraisal remains unchanged.
2. The economy has gained additional momentum. Recent figures suggest that output grew by 7.8 percent year-on-year in the first half of 2007, well above both the authorities’ and staff’s estimates of potential. High frequency indicators point to even stronger output growth in recent months. Such indicators also suggest that growth continues to be powered by very buoyant domestic demand, reflecting a surge in investments and continued strong growth in private consumption. Real wages increased by 17 percent during the first half of 2007, compared to the same period of last year. In light of these developments, the Ministry of Economy has announced that it will increase its 2007 forecast for real GDP growth, from 6.5 percent to 7.2-7.4 percent, while the consensus forecast has increased to 7.1 percent. Staff has for now maintained its forecast of 7 percent for 2007, but agrees that the risks are now mainly on the upside.
3. The current account surplus is continuing to decline at a relatively rapid pace. In the second quarter of this year, the current account surplus relative to GDP almost halved compared to the same period of 2006, even with oil prices at broadly the same level during these two periods.
4. Inflation has continued to increase. Since the issuance of the staff report, headline inflation (year-on-year) has risen above the official end-year target of 8 percent, from 7.4 percent in March to 8.6 percent in August. As discussed in the staff report, this trend mainly reflects the return to a more fixed exchange rate policy from mid-2006, a policy change that has been associated with a surge in capital inflows and unsterilized interventions. Since June, in an effort to stem the increase in inflation, the CBR has again allowed slightly greater exchange rate flexibility, with the ruble appreciating until mid-August, when capital outflows and downward pressures on the ruble associated with the current turmoil in financial markets prompted the CBR to intervene to support the currency (see below). While these outflows have eased short-term pressures on monetary policy, staff believes that the risks remain biased toward an overshooting of the end-year inflation target of 8 percent.
5. The authorities are still planning a notable fiscal relaxation in the context of a supplementary 2007 budget. Duma approval is now expected in October. The parameters of the supplementary budget remain as described in paragraph 18 of the staff report.
6. Russia has weathered the recent turmoil in world financial markets relatively well. Compared to the beginning of August, sovereign spreads increased by about 50 bps to about 150 bps, but have now stabilized. Similarly, after an initial drop of about 8 percent over the first half of August, the local stock market firmed after the Fed’s action on the U.S. discount rate, and ended the month down by only 5 percent. As foreign investors reduced their Russian exposure, the CBR acted intermittently to smooth downward pressure on the exchange rate, and there was a small loss of official reserves during August. However, despite this loss, reserves have increased by $113 billion so far in 2007, and currently stand at $416 billion.
7. Liquidity in the banking system has been restored. The CBR’s sales of foreign exchange, combined with significant end-August tax obligations, resulted in a domestic liquidity squeeze. Overnight money-market rates doubled from about 4 percent to 8 percent, prompting the CBR to inject a growing amount of liquidity via the one-day repo facility. At the peak of the liquidity squeeze, rolled-over repo operations reached a historic high of Rub 272 billion ($10.6 billion). Now that the tax-payment period is over, however, money-market rates have dropped to 5-6 percent, and repo operations are again minimal.
8. The turmoil in financial markets has increased the vulnerability of some banks. Staff remains particularly concerned that Russia’s fragmented and inefficient interbank market may leave some individual regional or mid-size banks vulnerable to a deterioration of credit conditions. Thus, some banks with limited access to the interbank market have relied on foreign borrowing as a key source of funds, and may face difficulty as the cost of this funding rises. An FSAP-update mission is scheduled to visit Moscow in October.
9. Recent developments have reinforced the thrust of the staff appraisal. In particular, staff continues to believe that further fiscal relaxation should be avoided at this juncture when the economy is gaining additional momentum spurred by strong domestic demand, and when inflation is already rising and the ruble is appreciating rapidly in real terms.