Russian Federation
2009 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion

This 2009 Article IV Consultation highlights that the banking system of the Russian Federation is under increasing strain, and private sector credit is contracting. The authorities’ response to the crisis has been swift and substantial, driven by concerns that weaknesses in the banking and corporate sectors could lead to a full-fledged crisis. Executive Directors have commended the authorities for a swift and substantial policy response to these developments. Directors have also encouraged the authorities to take a more proactive and concerted approach to tackling the problems in the banking sector.


This 2009 Article IV Consultation highlights that the banking system of the Russian Federation is under increasing strain, and private sector credit is contracting. The authorities’ response to the crisis has been swift and substantial, driven by concerns that weaknesses in the banking and corporate sectors could lead to a full-fledged crisis. Executive Directors have commended the authorities for a swift and substantial policy response to these developments. Directors have also encouraged the authorities to take a more proactive and concerted approach to tackling the problems in the banking sector.

I. From Overheating to Crisis1

A. Deteriorating Macroeconomic Situation

In the wake of the global financial crisis, the Russian economy has been hit hard by dual shocks—a collapse in oil prices and a sudden reversal of capital flows. Real GDP contracted sharply in the first quarter, as Russia’s investment boom came to an abrupt end. As a result, inflation pressures are easing. More recently, although rising oil prices and renewed capital inflows have provided some support to the ruble, the economy has continued to falter.

1. Following an extended period of overheating, the Russian economy is now contracting sharply. Prior to the global financial crisis, large terms-of-trade gains and surging capital inflows amid accommodative monetary and procyclical fiscal policies had fueled rapid credit growth and lifted output well above potential by mid-2008. However, the two key external drivers of Russia’s prolonged boom—rapidly rising oil prices and massive capital inflows—sharply reversed last summer, triggering an abrupt contraction in domestic demand. Fixed investment plummeted, shattering the nexus of high growth in investment, productivity, and real wages that had powered consumption and the economic boom. Real GDP contracted by 9¾ percent in Q1 2009 (year-over-year), while falling domestic demand led to a steep drop in imports.


Contribution to GDP Growth

(Percent, year-on-year)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

Actual and Potential Output

(Trillions of Russian rubles, annual, rolling, 2008 prices)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

2. Since the onset of the crisis in September, the ruble has depreciated by around 15 percent against the U.S. dollar-euro basket, but remains broadly in equilibrium. The currency first depreciated by about 30 percent over December-January, but has since recovered. Mirroring the evolution of the nominal rate, the ruble initially depreciated by some 15 percent in real effective terms, before reversing course in February, when it was close to equilibrium based on CGER analysis. Since then, it has appreciated somewhat, leaving it 5 percent more depreciated than its pre-crisis level. Even now, however, staff analysis suggests that the ruble remains broadly in equilibrium, as the recent increase in projected medium-term oil prices has implied a parallel appreciation of the equilibrium real effective exchange rate (Annex I).


REER and Inflation

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

3. Inflation is moderating gradually as the output gap is widening. CPI inflation remains stubbornly high, in part reflecting the depreciation of the ruble and an attendant rise of tradables inflation (excluding food). Nevertheless, declines in food and energy prices and faltering domestic demand have brought about some reduction in headline inflation—after peaking at 15.2 percent (y/y) in June 2008, it fell to 11.9 percent in June 2009.


CPI Inflation

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

4. Labor market conditions have eased considerably, dampening growth in real wages and unit labor costs. Labor utilization rates had reached record highs at the onset of the crisis, while real wages had been growing well above productivity on average for almost a decade. Since early 2009, however, employers have been shedding workers, pushing the unemployment rate to 9.9 percent in May. Labor productivity growth—measured as growth of real GDP per unit employment—has turned negative, exerting significant downward pressures on real wages. As a result, unit labor cost growth is slowing rapidly.


Unemployment Rate, Seasonally Adjusted


Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

Real Wages and Labor Productivity

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

5. Bank balance sheets are under increasing strain, and private sector credit is contracting (Figure 1). As the macroeconomic situation has deteriorated, the level of overdue loans has more than doubled since January, reaching 4.6 percent of total loans in May despite regulatory forbearance and anecdotal evidence suggesting substantial ever greening of loans. Moreover, in an environment of high uncertainty, banks have exhibited a strong preference for liquidity. Since monetary policy was abruptly tightened in January, the stock of credit has been falling, for the first time since end-2004. Indeed, controlling for the depreciation’s impact on the ruble value of foreign-exchange loans, credit fell by 1 percent over the first quarter. The contraction has affected both the household and corporate sectors, but particularly the former.

Figure 1.
Figure 1.

Russia: Credit Indicators, 2006-09

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Central Bank of Russia; Rosstat; and IMF staff calculations.

Credit Flows to the Economy

(Rolling 12-month basis, percent of GDP)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

6. After a period of significant pressure, the balance of payments has stabilized (Figure 2). Following a tightening of monetary policy and a large one-step devaluation in January, reserve losses stopped and the ruble began to recover. Rising oil prices have further strengthened the balance of payments since then.

Figure 2.
Figure 2.

Russia: Oil Prices and External Stability, 2001-10

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Haver Analytics; and IMF staff calculations.
  • The current account surplus has stabilized, after an initial decline. With oil export volumes stagnant, the drop in oil prices from last summer’s record highs has resulted in a notable fall in export values. However, rapid import growth, which had caused the current account surplus to steadily unwind even as oil prices were surging, has reversed abruptly owing to a steep contraction in domestic demand and the ruble depreciation. As a result, the current account balance has largely stabilized at around $8 billion.

  • Lax monetary policy alongside an inflexible exchange rate led to huge capital outflows during the second half of 2008, as rapidly declining oil prices quickly reversed exchange rate expectations. This, in turn, brought about a massive drive by the highly indebted corporate sector to hedge foreign currency exposure, alongside a reversal of the carry trade by foreign investors. Capital outflows, which reached $131 billion in the fourth quarter, took various forms: large portfolio withdrawals; increased holdings of cash foreign currency (including shifts from ruble to foreign currency deposits); rising bank net foreign asset positions; and loan repayments by the nonbank corporate sector. More recently, monetary policy tightening alongside ruble devaluation, resurgent oil prices, and an increase in investor risk appetite for Russian assets (including through the carry trade) have led to a limited resumptions of capital inflows. Indeed, in the first quarter of 2009, corporates were able to roll over nearly all of their foreign debt, while banks drew down their foreign assets to reduce foreign liabilities.

  • Gross international reserves declined from a peak of $598 billion in August 2008 to a trough of $375 billion in March 2009, before ticking up to over $400 billion by end-June.


Trade Balance (U.S. dollars)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

Private Sector Capital Inflows, Excluding Errors and Omissions

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities.

Gross International Reserves

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities

7. The sharp economic slowdown in Russia is having an adverse impact on its regional partners. It is spilling over to neighboring countries through trade, financial, and remittance channels.2 Although direct trade links with Russia and several countries in Central Asia and the Caucuses have weakened in recent years, such links remain strong with Belarus, Finland, Kazakhstan, Moldova, and Ukraine. Turkmenistan has also been hit hard, as gas exports to Russia have declined in response to the fall in European demand for Russian gas. With respect to financial channels, regional partners appear to have benefited from spillovers related to Russia’s vast oil-driven external savings earlier this decade, but those benefits have now been reversed. Some countries (Kazakhstan) have also suffered losses on investments in Russia. The remittance link is especially strong for countries in Central Asia (Tajikistan and Kyrgyz Republic) and the Caucasus (Georgia and Armenia) as well as in Belarus, Moldova and Ukraine. As the crisis has caused a particularly sharp decline in construction—where employment of foreign migrant workers is very high—it has prompted a large reverse migration. This has contributed to unemployment pressures and added to the demand for social services in home countries.

B. Policy Response to the Crisis

The authorities’ response to the crisis that erupted in the fall was swift and substantial, reflecting concerns that weaknesses in the banking and corporate sectors could lead to a full-fledged crisis. As a result, policy interventions initially focused on maintaining external and financial sector stability. However, as reserve losses mounted and capital outflows surged, the ruble was devalued and monetary policy tightened. The authorities also announced a large fiscal stimulus aimed at supporting domestic demand.

Monetary and Financial Policies

8. As the crisis intensified in the fall, the authorities’ policy response was aimed at avoiding a disorderly exchange rate depreciation and maintaining financial sector stability. The response was rapid, but was circumscribed by a number of policy-induced vulnerabilities that built up prior to the crisis. In particular, the authorities’ earlier focus on exchange-rate stability had encouraged substantial foreign-currency borrowing, and had contributed to unsustainably high rates of credit growth. Combined with supervisory shortcomings, this had left Russian banks and corporates particularly vulnerable to a reversal of inflows. Thus, the sudden change in exchange rate expectations triggered by the collapse in oil prices led banks and corporates to seek to hedge their foreign currency exposures, exacerbating pressure on the ruble. With the banking system under added pressure on account of deposit outflows and some bank failures, the policy response focused on maintaining stability and occurred in three distinct phases—accommodation, devaluation and tightening, and gradual easing.

  • Accommodation. Initial efforts were aimed at providing significant liquidity at low interest rates while keeping the exchange rate stable to offset to abrupt loss of foreign financing. The government auctioned excess budgetary funds to banks, while the CBR provided an ever-widening array of liquidity facilities, including uncollateralized loans. The CBR also offered guarantees for interbank lending to qualifying banks, covering losses in the event that the licenses of a counterparty is withdrawn. To bolster confidence in the banking system, the authorities also raised the deposit-insurance limit. However, the sizable liquidity provisions fueled further capital outflows. By mid-January, the pace of reserve loss had reached over $50 billion per month, while the total reserve loss since August amounted to over $200 billion.

  • Devaluation and tightening. Confronted with surging reserve losses, the ruble was devalued sharply and monetary policy tightened (Figure 3). Toward the end of January, the CBR allowed a one-off 10-percent weakening of the effective exchange-rate band, and declared that it would defend the ruble at the weak bound of this band. In addition, it started to curtail its liquidity support, allowing interest rates to rise to more market-based levels—at their peak, overnight interbank rates reached 28 percent. Repo interest rates increased by almost 300 bps in February to around 12 percent, while rates on unsecured loans rose by almost 500 bps to around 18 percent. In the event, pressure on the exchange rate eased almost immediately and reserves leveled off at around $380 billion.

  • Gradual easing. In light of a more stable currency and rising oil prices, monetary policy has subsequently been gradually eased. Repo rates have come down, reaching 8¾ percent by late June. Moreover, with renewed inflows, local liquidity conditions and interbank lending have improved, while the stock of uncollateralized loans provided by the CBR at the height of the crisis is being rapidly repaid ahead of schedule. As oil prices have risen, the ruble has appreciated in nominal terms against the dollar-euro basket and reserves have increased. However, banks remain cautious, preferring to hold deposits at the CBR rather than extend credit.

Figure 3.
Figure 3.

Russia: Monetary Tightening in the First Quarter, 2006-09

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Central Bank of Russia; and IMF staff calculations.

Crisis Liquidity Injections (Stock outstanding, trillions of Russian rubles, 2-week MA)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Central Bank of Russia; and IMF staff calculations.

Average Daily Repo Operations

(Volume, billions of Russian rubles)

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Russian authorities; and IMF staff calculations.

9. The sharp economic downturn is testing the resilience of the banking system, which remains reliant on CBR support and regulatory forbearance. The CBR introduced regulatory forbearance by easing loan classification and provisioning requirements. Moreover, the use of non-standard definitions for nonperforming and restructured/renewed loans has further masked the extent of deterioration in banks’ loan books, particularly given that evergreened loans are not reported as delinquent.3

Financial Sector Support Operations, 2008-09 1/

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Sources: Press statements; and the government’s anti-crisis program.

New facilities created as part of the government’s reponse to the 2008-09 financial crisis.

The CBR has also taken steps to loosen accounting standards to limit banks’ mark-to-market losses and to expand access to its unsecured loan auctions—with the latter increasing credit risk to the CBR. Although a number of small- and medium-sized banks have been taken into receivership, the combination of CBR liquidity provision and regulatory forbearance has allowed the banking system to weather the early stages of the crisis relatively well.

Fiscal Policy

10. Fiscal policy was expansionary in the second half of 2008, but the stimulus was withdrawn in the first quarter of 2009. With budgetary expenditures heavily backloaded—some 38 percent of expenditures were executed in the fourth quarter—fiscal policy provided a large demand stimulus toward the end of 2008. However, following the seasonal spending pattern observed in previous years, considerable retrenchment took place in the first quarter of 2009. The non-oil deficit of the general government fell from some 6 percent of annual GDP in the fourth quarter of 2008 to roughly ¾ percent of annual projected GDP in the first quarter of 2009—a withdrawal of over 5 percent of GDP.

11. In April of 2009, as the economy continued to contract, the government passed a large supplementary budget to support flagging domestic demand. The budget includes large discretionary increases in defense and security spending; along with a package of anti-crisis measures aimed at stimulating economic activity by reducing taxes, extending support to strategic sectors, and enhancing social assistance. As result, total expenditure is expected to increase by some 5 percent of GDP (text table). Excluding budgetary support to the financial sector, Russia’s announced discretionary fiscal stimulus is one of the highest in the G-20.


Discretionary Fiscal Measures of the G-20, 2009-10 Average

(Percent of GDP relative to 2007 baseline) 1/

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: G-20 meeting, Global Economic Prospects and Effectiveness of Policy Response, June 27, 2009, Basel, Switzerland; and IMF staff estimates.1/ Excluding financial sector support measures.

Federal Budget Expenditure by Functional Classification 1/

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Sources: Budget documents; and IMF staff calculations.

Based on 2009 Supplementary Budget.

Includes the disbursement for the Housing Fund in 2008 (0.6 percent of GDP).

II. Near Term Outlook and Risks

The Russian economy is projected to experience a deep recession in 2009, followed by a sluggish recovery. With the banking system expected to remain under strain, credit growth would turn negative and impede a robust rebound. Risks around this outlook are to the downside.

12. GDP growth is likely to recover only slowly. Going forward, the external environment is likely to remain challenging, as the subdued outlook for global growth implies only a gradual recovery in commodity prices. Moreover, global deleveraging by financial institutions suggests that capital inflows to emerging economies, including Russia, are unlikely to return to their pre-crisis levels any time soon. Against this background, real GDP is expected to contract by 6 ½ percent in 2009, after expanding at an annual rate of 78 percent before the crisis. Growth is projected to recover only slowly over the course of 2010, despite oil prices that are significantly higher than previously expected.4

Key Economic Indicators

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Sources: Russian authorities; and IMF staff projections.
  • Compared to before the crisis, much lower oil prices and a sharp turn-around in capital flows are expected to exert a significant drag on domestic demand. In particular, with capital flows projected to remain limited, the investment-consumption nexus that underpinned Russia’s impressive economic performance in recent years is likely to be severed. Fixed investment would remain subdued in the face of heightened uncertainty and reduced credit availability. With sluggish investment growth dampening labor productivity, real wages are likely to remain stagnant. While the planned large fiscal stimulus is expected to provide temporary support for private consumption, weak labor market conditions would continue to weigh on private consumption well into 2010.

  • The current account surplus would decline in 2009 before improving modestly in 2010. Imports are projected to fall steeply in 2009, with import growth turning weakly positive in 2010, in line with domestic demand. This, combined with the expected gradual recovery of oil prices, would lead to an improvement in the current account balance. Taking into account the planned large-scale monetization of the fiscal deficit, capital outflows are expected to remain relatively high at $68 billion. With an overall balance-of-payments deficit of about $50 billion in 2009, reserves would decline to some $375 billion by end-year.

  • Uncertainty regarding the state of bank balance sheets, including the extent of bad assets and the potential capital shortfall, and the impact of the recession on the corporate and household sectors is expected to significantly increase banks’ liquidity preferences and limit the expansion of credit. As a result, nominal credit is projected to remain relatively flat for the rest of the year, implying a drop of some 10 percent in real terms.

  • Inflationary pressures are expected to ease substantially as the output gap widens. However, headline inflation is expected to decline only slowly during the remainder of 2009 on account of base effects, falling to 11 percent by year-end. A further decline is expected in 2010.

13. Risks around this highly uncertain outlook are to the downside. Continuing uncertainty about the depth and duration of the global financial crisis implies a wide range of potential outcomes on either side of staff’s baseline projection. The current projection takes into account the authorities’ strong countercyclical fiscal stance, and assumes a gradual bottoming-out and a slow recovery in Russia. However, a more protracted global downturn—and an attendant decline in commodity prices—would result in a delayed recovery and even lower growth, particularly in 2010. Moreover, the planned fiscal relaxation might fail to stimulate private consumption in the face of significant uncertainty about future income. In addition, absent a more determined policy intervention, there is a risk that banks will continue to struggle to adjust balance sheets, stifling credit expansion and impeding a recovery. Finally, in the context of large external debt amortization coming due to 2009 and 2010 (text table), a renewed bout of global risk aversion could strain bank liquidity and add to funding pressures facing corporates, with an attendant risk that growth could be lower.

Projected Amortization of External Debt, 2009-10

(Billions of U.S. dollars)

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Sources: CBR and IMF staff estimates.

III. Policy Discussions

A. Financial Sector Policies

While the regulatory and supervisory framework has improved significantly in recent years, remaining weaknesses—including the lack of comprehensive consolidated supervisory powers—have hampered the CBR’s ability to ascertain the full extent of the deterioration in banks’ portfolios. Overdue loans are expected to rise further as the economy continues to falter, increasing pressure on banks’ capital adequacy. Thus, a proactive and comprehensive plan to address the looming overhang of bad assets and associated capital shortfalls is urgently needed to lay the foundation for a resumption of credit growth.

14. Despite significant improvements, ongoing limitations in Russia’s regulatory and supervisory framework are impeding a full assessment of the problems in the banking system. The CBR’s monitoring of systemic risks has improved in recent years, as it has made extensive efforts to bolster its financial stability analysis capabilities. Clear progress has also been made with respect to day-to-day supervision over institutions and the supervisory staff has been strengthened. That said, generous accounting and provisioning rules continue to hamper the CBR’s ability to gauge the quality of assets and the adequacy of their loan-loss reserves, heightening uncertainty about the creditworthiness of Russian banks. Given shortcomings in reporting requirements for consolidated financial statements, there is significant uncertainty regarding the activities of banks’ off-balance sheet activities—including the extent to which they are being used to offload bad assets. This weakness is compounded by the lack of adequate powers afforded to the CBR to monitor and supervise bank holding companies and sanction bank officers and directors. These issues were highlighted in the 2008 FSAP update.

15. Overdue loans are expected to increase sharply over the course of the year, denting capital adequacy. Although Russian banks appear to be relatively well capitalized, the need for increasing loan-loss provisions will likely result in sizeable losses to banks’ profits and capital adequacy. The scale and scope of possible capital shortfalls remains somewhat uncertain, given the flexible restructuring standards and the difficulties in ascertaining the extent of bad assets. The government has set aside Ruble 500 billion (1¼ percent of GDP) to support bank recapitalization and the modalities for such support are in the process of being finalized.

16. Staff strongly encouraged the CBR to develop a proactive and comprehensive plan to deal with problem banks, guided by systemic stress tests and contingency plans. On the basis of such stress tests—which need not be made public—viable banks should be recapitalized, merged with healthy banks, or restructured. Absent a systematic analysis of individual banks, it is unclear whether the funds set aside for recapitalization will be sufficient.

  • Detailed reviews and mandatory systemic stress tests—utilizing similar assumptions and the same point-in-time balance sheets—should be undertaken for large- and medium-sized banks to contribute to a more comprehensive assessment of banks’ financial health, including estimates of viability and capital needs. While different options would need to be considered for recapitalizing viable banks—including the scope for burden sharing between the private and public sector—it is critical that the authorities move quickly and convincingly. Moreover, regulatory guidance should be developed to provide banks with a roadmap of the supervisory actions that the CBR intends to implement as banks’ capital deteriorates and the level of problem loans increases. This would enable banks to plan early to either increase capital from private sources or to attempt to find a buyer. Staff noted that the CBR may require additional resources to undertake labor-intensive stress tests and to intensify monitoring of systemically important banks.

  • Staff and the authorities concurred on the need to develop contingency plans and resolution strategies. This would bolster the authorities’ ability to proactively address potential future problems in the banking system. In light of the potential for a significant increase in bank resolutions, the DIA should develop plans for the orderly disposition of large volumes of assets from liquidated banks or from DIA-assisted mergers, as well as a possible rise in deposit payouts. Moreover, given the CBR’s intention to roll back regulatory forbearance, staff encouraged the development of a communication strategy to explain how the rollback would be implemented and the procedures that the CBR would adopt for determining compliance with capital requirements after the rollback.

  • Staff welcomed Russia’s participation in international fora—including its membership in the Basel Committee on Banking Supervision—aimed at improving international coordination in the areas of regulation, resolution, and information sharing. The authorities’ efforts to coordinate with home-country supervisors might help to avoid an abrupt unwinding of foreign exposures in Russia, and foster a better understanding of the potential vulnerabilities in Russian banks’ cross-border positions.

17. The CBR agreed that the situation in the banking system was deteriorating, but viewed the problems as manageable. It did not expect a renewed bout of severe stress. Although CBR officials concurred that the need for increased transparency in bank reporting and the lack of consolidated supervisory powers hampered their ability to obtain a comprehensive picture of the situation in the banking system, they believed that emerging problems could be handled within the existing framework for bank regulation and supervision. In particular, they did not see the need for systemic stress tests of banks, underscoring that ad-hoc stress tests were already conducted as part of their regular supervision activities. Moreover, since August 2008, the CBR has stepped up the intensity of supervision, including by supplementing the on-site work of its regional branches and by collecting detailed information from the 34 banks that had received government funds. Draft legislation is under review within government to expand the CBR’s consolidated supervision authority and is expected to be presented to Duma later this year.

B. Fiscal Policy

Despite persistent underexecution, fiscal policy had become increasingly pro-cyclical in the years preceding the crisis. This reflected growing political pressures to spend more of Russia’s oil wealth on investment and other strategic projects, as well as a failure to curb current expenditures. In view of these pressures, and considering the importance of saving much of this wealth in order to avoid excessive real appreciation as private consumption returns to normal, staff is concerned that the significant planned relaxation will be difficult to reverse. Thus, while a large fiscal stimulus is justified at this juncture, its size should be limited and its composition reoriented toward expenditures that are better-targeted and self-reversing.

18. A large fiscal expansion is underway. The headline balance is expected to swing from a surplus of 4¼ percent of GDP in 2008 to a deficit of about 5½ percent in 2009—a turnaround of nearly 10 percent of GDP. Oil revenues are projected to fall by about 4¼ percent of GDP at current WEO oil prices. The remainder of the decline in the general government balance reflects a large fiscal stimulus, with expenditures set to rise by over 5 percent of GDP in the second half of the year. As a result, the non-oil deficit of the general government is projected to increase by 5½ percent of GDP—reaching 13¾ percent of GDP. The deficit will be monetized by drawing down the oil Reserve Fund, except for domestic borrowing of up to 1 percent of GDP.

19. The composition and size of the fiscal stimulus raise questions about its reversibility and effectiveness. In particular, the current expenditure and tax structure could become entrenched. This would make it difficult to achieve the authorities’ medium-term fiscal target, implying an eventual return to a highly procyclical fiscal stance with upward pressures on prices and the real exchange rate.

  • Given the 2009 budget, bringing the non-oil deficit down to the authorities’ 4.7 percent of GDP medium-term target would require an adjustment in expenditure or non-oil revenues of some 9 percent of GDP over the next four years. Taking into account budgetary financing of critical reforms to the pension system (averaging 3 percent of GDP annually5), as well as costs associated with support to the banking sector, the required adjustment could exceed 11 percent of GDP. Moreover, looking ahead, staff calculations, based on a permanent oil income model, suggest that additional adjustment, beyond the 4.7 percent of GDP non-oil deficit limit, may be needed to ensure long-term fiscal solvency (Annex II). With an already high tax burden, and with non-statutory federal spending amounting to only 7¼ percent of GDP, fiscal adjustment on this draconian scale would only be possible with deep and comprehensive public sector reforms.

  • In view of these considerations, staff believes that the change in the non-oil deficit should be kept to 2-3 percent of GDP in 2009 and its composition improved. A better targeted, yet smaller, stimulus could have a similar impact on economic activity, given the larger fiscal multipliers, but would reduce the risk of causing a permanent change in the tax and expenditure structure. In particular, expenditure savings could be achieved by reducing support to strategic enterprises and streamlining non-essential defense outlays. Staff also recommends reorienting the stimulus toward a temporary increase in social transfers targeted on credit-constrained households, and suggests a frontloading of infrastructure projects for which preparations are advanced alongside a strengthening of procurement procedures. This improvement in the composition of fiscal spending would also facilitate the withdrawal of stimulus once private demand recovers, as many of the measures would be self-reversing. In this regard, plans for frontloading the pension reform are appropriate, as long as the additional outlays are accommodated by reducing other, less efficient, spending.

  • Looking to 2010, if a smaller non-oil deficit is targeted in 2009, there would be scope to maintain the fiscal stimulus next year if needed. The desirability of maintaining, rather than withdrawing, the stimulus in 2010 depends critically on the growth outlook, which is highly uncertain. Under the current outlook, and assuming the 2009 stimulus is scaled back and reoriented as described above, maintaining the stimulus next year would provide important support to domestic demand. However, if the growth outlook improves, some withdrawal of stimulus (of around 1 percent of GDP) would be appropriate in 2010.

20. The authorities and staff agreed that it would be difficult to unwind the fiscal stimulus in 2010 in its current form. Officials at the Ministry of Finance were particularly concerned that spending pressures would continue next year, especially if the economy did not recover quickly. They also viewed the composition of the stimulus as suboptimal, noting that fiscal multipliers were likely to be small. Moreover, given that the stimulus package was approved only in April, they were concerned that it would be difficult to implement effectively such a large stimulus in the remaining 6-7 months. As a result, it was possible that the planned stimulus would be underexecuted in 2009. However, there were no plans to introduce a supplementary budget aimed at reducing the size of the stimulus. In view of the exceptionally large uncertainties surrounding the outlook for 2010, the authorities have decided to delay the submission of the 2010 budget to the Duma until the fall.

21. To facilitate the large fiscal adjustment needed over the medium term, staff and the authorities agreed that reinvigoration of public-sector reforms was a matter of priority.

  • Staff welcomed the authorities’ commitment to advancing reforms in the health and education sectors. IMF research suggests that Russia has scope to achieve significant budgetary savings by improving expenditure efficiency, without compromising the quality of services.6 Such savings could be particularly large in healthcare and social protection, but public sector reforms in other areas, including civil service, military, and education, would also be instrumental in creating the much-needed fiscal space.

  • Staff also supports the authorities’ plan to gradually replace the current revenue-based oil taxation regime with a profit-based system (Annex III). Such a system would be more closely tailored to differences in costs over time and across fields, and would better balance the need to ensure a sufficient oil revenue take by the government against the desirability of creating strong incentives to invest in oil exploration and production. However, it was agreed that a necessary precondition for adopting such a system would be the introduction of transfer-pricing legislation consistent with OECD guidelines and a strengthening of enforcement capacity.

C. Monetary Policy

With inflation declining, there is room to ease further the monetary policy stance. However, given that the large liquidity injections associated with monetization of the fiscal deficit may create risks to external stability, the CBR should move cautiously in reducing interest rates. Looking farther ahead, the challenge for monetary policy will be to bring down entrenched high inflation, with a view to bolstering Russia’s capacity to mobilize domestic savings to fund much-needed investment.

22. There is scope for a more accommodative monetary policy stance (Figure 4). Staff and the authorities agreed that there is room to cut policy interest rates in light of a widening output gap and declining inflation. However, the direct impact of lower interest rates on domestic demand would likely be somewhat limited at first. Banks facing mounting overdue loans and rising credit risk were likely to scale back the supply of credit as they attempted to build liquidity and strengthen their balance sheets. At the same time, general uncertainty about the economic situation was likely to reduce the demand for credit. Nonetheless, lower interest rates should help reduce bank funding costs and support the financial system.

Figure 4.
Figure 4.

Russia: Monetary Policy Indicators, 2002-09

Citation: IMF Staff Country Reports 2009, 246; 10.5089/9781451833195.002.A001

Sources: Central Bank of Russia; Haver analytics; and IMF staff calculations.1/ 3-month MIBOR; real rate deflated by most-recent 3-month CPI inflation (annualized, s.a.)2/ MCIt = MCIt-1* [1 + (rt - rt-1) + at × log(REERt / REERt-1)], where rt is the real 3-month interest rate, and at is the time-varying average of the export and import-to-GDP ratios.

23. Staff and the authorities agreed that the challenge for monetary policy in the short run will be to strike the right balance between domestic and external stability. Monetization of the fiscal deficit by drawing down the oil Reserve Fund would represent a substantial injection of liquidity—amounting to around 70 percent of base money during the remainder of 2009, under the assumption that the budget is fully executed. Although the CBR expects a large portion of this to be sterilized, in part through the repayment of the uncollateralized loan stock, staff still projects a net liquidity injection of around 35 percent of base money.7 This is a significant injection into a banking system that is already liquid and that is likely to continue to have strong liquidity preferences on account of high uncertainty. This points to the risk that an excessive reduction in interest rates, or renewed expectations of ruble depreciation in the face of a reversal of the recent oil price increase, might induce banks and investors to shift out of rubles and into foreign exchange, putting excessive downward pressures on the exchange rate. In view of this, staff believes that the CBR should move cautiously in reducing policy rates. For their part, CBR officials noted that they stood ready to halt the reduction in interest rates as needed to preserve external stability.

24. Staff welcomed the CBR’s policy of increased exchange-rate flexibility and urged the CBR to keep monetary policy focused on reducing inflation.

  • Staff noted that the resumption of short-term capital inflows—most notably the carry trade—underscored the importance of allowing the ruble to move flexibly, in both directions, to avoid exacerbating short-term speculative inflows associated with one-way bets on the currency. Staff acknowledged that an abrupt and dramatic shift in exchange rate expectations and a reversal of capital inflows—perhaps associated with a rapid decline in oil prices—could be cushioned by drawing on Russia’s substantial international reserves. But ultimately, the authorities should stand ready to let the exchange rate move in line with longer-term fundamentals.

  • Staff urged the CBR to refocus monetary policy on inflation control. It noted that the crisis has laid bare the cost of orienting monetary policy toward nominal exchange rate stability, as it has allowed high inflation to remain entrenched, at levels well above those of G-20 peers. The consequences of this policy may be particularly severe in an environment of limited external financing which is likely to prevail in the years to come. In particular, the capacity of Russia’s financial system to mobilize long-term financing to fund much-needed investment is likely to remain limited as long as inflation stays high, impeding an expansion of the Russia’s productive capacity. Concerns in this regard are heightened by the risk of continued procyclicality in fiscal policy even as GDP growth begins to recover, which could spark renewed upward pressure on the real exchange rate. This risk makes maintaining exchange rate flexibility particularly important, as it will be critical that such real exchange rate pressures are not reflected in higher inflation.

25. The authorities agreed with the importance of reducing inflation and expected to achieve steady progress in this regard. In particular, they were committed to the maintaining the higher degree of exchange rate flexibility seen since the beginning of the year. However, given the importance of primary commodities to the balance of payments and the volatility of commodity prices, they felt that it was pre-mature to commit to allowing the exchange rate to fully respond to changing fundamentals at this stage. In this regard, while much of the technical preparatory work is now in place, the authorities felt that it was too early to commit to a timetable for moving to inflation targeting.

D. Structural Reforms

Boosting Russia’s long-term growth potential depends critically on advancing structural reforms, including through accession to the WTO. However, the accession process appears to be loosing momentum.

26. Staff inquired about the prospect for reinvigorating reforms that would help bolster Russia’s investment climate, including membership in the WTO. It noted that Russia continues to score poorly on cross-country comparisons of the investment climate, not least because of what is perceived to be heavy government interference in the economy. Moreover, limited competition and lack of new entries are seen to be encouraging rent seeking. Staff noted that important reforms in this regard appear to have stalled during the period of high and rising oil prices—not least civil service and public administration reforms—and it also expressed concern that support for early WTO accession seemed to be loosing momentum. In this regard, staff noted that, as the scope for catch-up gains in productivity begins to diminish, long-term growth will become increasingly dependent on boosting investment, including by improving Russia’s still relatively poor investment climate. The fact that the labor force is set to decline steadily, because of unfavorable demographical factors, adds to the urgency of bolstering long-term growth by encouraging investment. Staff also encouraged the authorities to maintain an open trade regime and avoid protectionist measures.

27. The authorities agreed on the need to move ahead with structural reforms. In this regard, they confirmed that many reform aimed at improving the investment climate and bolstering institutions were technically relatively well-advanced. However, as far as implementation is concerned, the focus would be on areas critical to controlling public spending, notably reforms to the health and education sectors. While stressing that WTO accession remained an important goal, officials expressed frustration about the prolonged process, acknowledging that it appeared to have lost some momentum. Indeed, shortly after the mission, Russia suspended its bilateral bid for WTO membership, seeking instead to join in partnership with Belarus and Kazakhstan as part of a customs union.

IV. Staff Appraisal

28. The Russian economy has been hard hit by dual shocks as the two key drivers of its prolonged boom—rapidly rising oil prices and massive capital inflows—have suddenly reversed. Indeed, the swing in growth has been much stronger in Russia than in its G-20 peers—despite a much larger fiscal stimulus than in many of these countries—and prospects for an early recovery also appear less promising, barring an unexpected strong rebound in the global economy and an attendant rally in commodity prices. The depth of the crisis, but also the large scope for countercyclical policies, should serve as reminders of longstanding strengths and weaknesses in economic policies.

29. Financial sector weaknesses and large external exposures have circumscribed the policy response to the crisis. Faced with bank failures and deposit withdrawals, the authorities initially provided low-interest rate ruble credits and intervened heavily to slow the currency’s depreciation. This deliberate policy of cushioning the impact of the crisis likely prevented a wave of corporate bankruptcies, stabilized the situation in the banking system, and generally improved prospects by allowing cheap hedging of excessive foreign exposures against ruble devaluation. But the unsustainable pace of reserve losses eventually forced the authorities to abandon this costly policy—which clearly exacerbated capital outflows—and prompted a significant tightening of monetary policy and a large depreciation of the ruble. This policy shift has brought banking sector problems to the fore, revealing and exacerbating pressures that had begun building with the sharp slowdown in the economy. Thus, banks’ financial situation and loan portfolios are now deteriorating at a notably faster pace. The key immediate challenge facing the authorities at this time is how to deal with these mounting problems.

30. The authorities need to take a more proactive and concerted approach to tackling the problems in the banking sector. Absent such an approach, there is a notable risk of a prolonged credit freeze, as uncertainty about counterparty risks continue to linger and banks become increasingly undercapitalized. A more proactive approach should include mandatory, bottom-up stress tests of larger banks; a roadmap laying out the likely supervisory responses as bank’s capital deteriorates and the level of problem loans increases; and a strengthening of the CBR’s supervisory authority, not least by granting it broader consolidated powers. Considering the exceptionally large number of small banks—and taking advantage of the existence of comprehensive deposit insurance—the CBR should, in the view of staff, be more willing to compel bank closures and consolidation. Importantly, despite the explosive credit growth in recent years, the banking system is still small with credit-to-GDP at about 40 percent. This implies that the potential cost of recapitalizing systemically important institutions is unlikely to pose a major fiscal burden.

31. The planned fiscal relaxation is excessive. Taking into account the projected cost of urgently needed pension reforms, the relaxation will increase the non-oil deficit by some 1113 percent of GDP above the level prescribed by the government’s medium-term fiscal framework. With non-statutory federal spending of only some 7¼ percent of GDP, fiscal consolidation on this draconian scale will require unprecedented deep public sector reforms. With little evidence of support for such reforms, and considering the spending pressures that led to increasingly pro-cyclical policies before the crisis, staff would urge the authorities to scale back the fiscal stimulus, from 5½ to about 2½ percent of GDP, and reorient its composition toward measures that are self-reversing. Thus, while there is a case for a strong discretionary relaxation, there is a need to better balance short-term cyclical considerations and the medium-term objective of ensuring prudent spending of oil wealth. Without such rebalancing, there is a risk that fiscal policy will become highly procyclical once private demand normalizes, causing excessive real appreciation and stifling the diversification of the economy away from its dependence on primary commodities.

32. As to monetary policy, there is a case for continuing to reduce policy rates. While a large-scale monetization of fiscal deficits is in store, staff agrees that the CBR should be able to manage this by allowing the large stock of maturing uncollateralized credits to expire. Still, banks will be highly liquid—reflecting a strong liquidity preference on their part in the current highly uncertain environment—and the reduction in interest rates should proceed slowly, taking into account the impact on ruble. In this regard, staff would also agree that the CBR should stand ready—in the event that unexpected developments, notably a renewed drop in oil prices, unsettle exchange rate expectations—to support the ruble, allowing a further reduction in reserves. However, the increased exchange rate flexibility since the beginning of the year has helped stabilize the balance of payments, and interventions should be only temporary.

33. Looking beyond the immediate policy response to the crisis, recent developments point to important lessons regarding the macroeconomic policy mix and objectives and the urgency of structural reforms.

  • The prudent policy of taxing and saving most of the oil revenue windfall during the good years, and the attendant large buildup of reserves, has left Russia with ample room to allow for a significant countercyclical fiscal expansion, including a large discretionary stimulus. It also allowed monetary policy to cushion the initial shock, giving the private sector time to adjust.

  • But the pre-crisis policy of controlled ruble appreciation, alongside regulatory shortcomings, encouraged excessive foreign currency borrowing at a time when high oil prices increased foreign appetite for Russian assets. The result was an oil-price related surge in capital inflows and an associated credit explosion. Thus, while prudent fiscal policy did prevent the commodity boom-and-bust through the current account, policy weakness in other areas in effect allowed it through the capital account.

  • The inflexible exchange rate policy also led to entrenched high inflation as the inevitable large real appreciation associated with the terms-of-trade gains was taken through price adjustment. This has severely constrained the availability of long-term ruble financing and left the financing of long-term investment projects dependent on foreign sources. Thus, the cost of entrenched inflation is becoming increasingly evident now that access to foreign financing is likely to be limited for some time as the process of global deleveraging plays out.

  • Last but not least, the depth of the crisis is in part due to the failure to advance reforms aimed at improving the investment climate and promoting diversification of the economy. In particular, during the years of high oil prices, little progress was made in advancing the many reforms that are important to curtailing the still pervasive government interference in the economy and to increasing competition and reducing rent-seeking.

34. Against this background, policy priorities—once the current crisis subsides—should be geared toward medium- and long-term objectives. These include: refocusing fiscal policy on the non-oil deficit, which should be credibly anchored on a target that is sustainable from a long-term perspective; reorienting monetary policy toward controlling inflation, in the context of a fully flexible exchange rate policy; and reinvigorating structural reforms, notably public administration and civil service reforms, reforms of the judiciary, and the drive to gain early accession to the WTO.

Table 1.

Russian Federation: Selected Macroeconomic Indicators, 2006-10

(Percent change, unless otherwise indicated)

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Sources: Russian authorities; and IMF staff estimates.

Excludes one-off tax receipts from Yukos in 2007.

Months of imports of goods and non-factor services.

Table 2.

Russian Federation: Balance of Payments, 2006-10

(Billions of U.S. dollars, unless otherwise indicated)

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Sources: Central Bank of Russia; and IMF staff estimates.

Excluding repos with non-residents to avoid double counting of reserves. Including valuation effects.

Excludes arrears.

Net of rescheduling.

Includes indebtness of repos by the monetary authorities.

Table 3.

Russian Federation: Fiscal Operations, 2006-10

(Percent of GDP)

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Sources: Russian authorities; and IMF staff estimates.

Based on the 2009 supplementary budget.

Based on the authorities’ target for the federal government overall balance of 5 percent of GDP and the Urals oil price of USD 72 per barrel.

Excludes a one-off receipt of tax arrears from Yukos in 2007 and one-off transfers from Nanotechnology and Housing Funds in 2009.

Table 4.

Russian Federation: Financial Soundness Indicators, 2003-09 1/


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Source: Central Bank of Russia.

Credit and depository institutions.

As of April 1, 2009.

Table 5.

Russian Federation: Monetary Accounts, 2006-10

(Billions of rubles, unless otherwise indicated)

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Sources: Russian authorities; and IMF staff estimates.

Data calculated at accounting exchange rates.

Represents the government’s use of NIR resources and calculated in flow ruble terms.

Inclusive of valuation gains and losses on holdings of government securities.

The drop in the multiplier in 2007 includes an increase in reserve requirements from 2.5 to 4 percent in July 2007.

Historical data from International Financial Statistics (IFS). A positive number implies real effective appreciation.

Table 6.

Russian Federation: Macroeconomic Framework, 2006-14

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Sources: Russian authorities; and IMF staff estimates.
Table 7.

Russian Federation: Indicators of External Vulnerability, 2004-08

(Percent of GDP, unless otherwise indicated)

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Sources: Russian authorities; and IMF staff estimates.

Gross debt of the general government.

Series discontinued in 2008.