Russian Federation
Staff Report for the 2012 Article IV Consultation
Author:
International Monetary Fund
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Publication Date:
03 Aug 2012
eISBN:
9781475505030
Language:
English
Keywords:
ISCR; CR; fiscal policy; Russia; Nonoil balance excl. one-off receipt; market; bank; reserve fund; broad money; interest rate; headline inflation; Correspondent banking; Global
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The Russian Federation economy saw growth of about 4 percent and a current account surplus—the result of favorable harvest, high oil prices, and reduced unemployment and inflation. Implementation of structural reforms initiated by the Central Bank of Russia (CBR), managing domestic demands, and non-vulnerability to oil price variation were suggested by the Executive Board as short and mid-term challenges. Strengthening monetary policy framework, allowing greater exchange rate flexibility, implementing Financial Sector Assessment Program (FSAP) recommendations, expansion of CBR powers, reduced state involvement in the economy, and enhancement of communication policies were also recommended.

Abstract

The Russian Federation economy saw growth of about 4 percent and a current account surplus—the result of favorable harvest, high oil prices, and reduced unemployment and inflation. Implementation of structural reforms initiated by the Central Bank of Russia (CBR), managing domestic demands, and non-vulnerability to oil price variation were suggested by the Executive Board as short and mid-term challenges. Strengthening monetary policy framework, allowing greater exchange rate flexibility, implementing Financial Sector Assessment Program (FSAP) recommendations, expansion of CBR powers, reduced state involvement in the economy, and enhancement of communication policies were also recommended.

Recent Developments

The Russian economy has recovered from the 2008–09 crisis and the output gap is estimated to now be closed.

1. Russia’s recovery continued in 2011 and the momentum continued in the first quarter of 2012. Russia recorded growth of 4.3 percent in 2011, the same as in 2010. Economic activity rebounded in the second half of the year on the back of a favorable harvest and high oil prices (Figure 1) and the momentum continued in the first quarter of 2012. Strong real wage and consumption growth have supported demand. Unemployment has continued to decline, reaching pre-crisis lows, and the capacity utilization of the manufacturing sector has recovered its 2007–08 level. While short-term economic indicators suggest some moderation of activity in recent months, the output gap is estimated to have been closed since 2011:Q4.

Figure 1.
Figure 1.

Russian Federation: Production Indicators and Inflation Developments, 2008–12

(Annualized quarter-on-quarter growth rate of seasonally adjusted 3-month moving average, unless otherwise indicated)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Rosstat; Ministry of Economic Development (MED); and IMF staff estimates.
uA01fig01

Quarterly GDP, seasonally adjusted, and Output Gap

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

2. Inflation has declined significantly recently, largely due to one-off factors. Aided by the moderation of food price inflation, the base effect, and a 6-month delay of the usual annual increase in administered prices in January, headline inflation has fallen from 9.6 percent (y-o-y) in mid-2011 to a historic low of 3.6 percent in May 2012. However, staff’s measure of core inflation—a good proxy for trend inflation—remains high at around 6 percent, indicating that inflationary pressures in the second half of this year will be considerable as the temporary factors disappear.

uA01fig02

Labor Market Conditions,

(Annualized seasonally adjusted growth)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Rosstat; and IMF staff calculations.

3. While the current account has been strengthening, net capital outflows persist. The current account surplus increased from 4.7 percent of GDP in 2010 to 5.3 percent in 2011. On the export side, rising oil prices contributed to a 31 percent increase in export values in 2011. However, strong oil export receipts were partly offset by high import growth. Net capital outflows intensified significantly in the second half of the year, reflecting a global flight to safety related to the turbulence in the euro area as well as the uncertainties surrounding the elections. At the same time, with the Central Bank of Russia (CBR) largely refraining from intervening in the foreign exchange market, the large net private capital outflows broadly mirrored the current account surplus in 2011.

uA01fig03

Current Accout Balance and Capital Flows

(Percent of GDP)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Source: Central Bank of Russia.

4. The exchange rate has become more flexible. During the international market turmoil in the late summer of 2011, and again during May-June 2012, the ruble depreciated by over 10 percent on each occasion (both times followed by a swift rebound of comparable magnitude). Since the summer of 2011, the authorities adhered to their new, more flexible framework and interventions were relatively modest. International reserves increased by $19bn in 2011, partly due to evaluation effects. The staff’s external sector assessment found that in 2011 the external position was moderately weaker than one consistent with medium-term fundamentals and appropriate policy settings (Box 1).

uA01fig04

Russia: Ruble Flexibility Versus Euro-Dollar Basket, 2005-12

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Source: Bloomberg.

5. Recent global turmoil heavily impacted Russia’s markets. The MICEX stock market fell 17 percent in 2011, reaching a nadir in October as euro-area tensions peaked. In 2012, however, the stock market added 16 percent in Q1 but lost all the gains during May’s global flight to quality episode. Similarly, Russia’s EMBI+ sovereign spreads rose to a peak of 410 bps in October 2011, and stood at about 275 bps in June 2012.

6. Credit growth has rebounded strongly. This growth partly reflected a switch by the corporate sector from external to domestic funding. At the same time, consumer credit grew strongly. On the credit supply side, improving bank balance sheets (with declining nonperforming loan (NPL) ratios and improving profitability) and funding (reflecting solid deposit growth and the CBR’s liquidity provision) allowed an expansion of lending (Figure 2).

Figure 2.
Figure 2.

Russian Federation: Banking Sector Developments, 2008–12

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Central Bank of Russia; and IMF staff estimates.1/ For methodology regarding the calculation of the probability of banking sector distress, please see Euro Area Policies: Spillover Report for the 2011 Article IV Consultation (IMF Country Report No. 11/185).

7. Fiscal policy tightened. The federal nonoil deficit declined from 12.7 percent of GDP in 2010 to 9.8 percent of GDP in 2011. This improvement was due to both nonoil revenue overperformance and expenditure cuts. Some of the windfall oil revenues from 2011 were deposited in the Reserve Fund in early 2012 (Figure 3).

Figure 3.
Figure 3.

Russian Federation: Fiscal Policy, 2004–12

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Russian authorities; and IMF, World Economic Outlook.* As of June 1, 2012.

Outlook

A. Near-Term Outlook and Risks

8. The outlook is for continued moderate growth; inflation will rebound under unchanged policies. Staff projects real growth at around 4 percent in 2012 and 2013, with potential GDP growing at a slightly lower rate, leading to moderate overheating. The unimpressive growth rate of potential GDP reflects the slow progress with productivity-enhancing structural reforms and the weak investment climate. Inflation is projected to rebound to 6½ percent by end-2012, reflecting the economy running above potential, the base effect, and the delayed increases in administered prices in mid-2012. The external current account surplus is projected to decline, amid weaker oil prices and continuing strong import demand. Capital outflows will likely continue, albeit at a moderating pace.

9. Near-term risks are balanced but remain considerable. On the upside, higher oil prices could push growth higher. Further, some reversal of capital outflows is also possible, in the event of higher oil prices, diminished political uncertainty, and a quick start on implementing credible structural reforms, adding more pressures to domestic demand and inflation. Finally, fiscal policy could become looser, following pre-electoral promises. On the downside, external shocks—for example, a further decline in oil prices, weaker investment sentiment, and lower external demand—or domestic complacency and a lack of reform could weaken the growth outlook as discussed in the Risk Assessment Matrix (Annex I). A strong intensification of financial turmoil in the euro area accompanied by lower growth would affect Russia mostly through the oil channel. While the Russian economy is also exposed to risks of accelerated capital outflows and sudden stop of external funding, the more flexible exchange rate, the improved crisis management capacity, and large international reserves would help Russia better handle an intensification of external shocks. A weaker growth outcome in Russia would have knock-on effects throughout the region, mainly through remittances and trade (Box 2).

10. Policy actions could cushion the impact of adverse spillovers if downside external shocks materialize. The exchange rate should be allowed to operate as the main shock absorber. Sufficient liquidity should be provided to banks, with the CBR making emergency liquidity facilities available as needed to mitigate the impact on banks (while providing for adequate safeguard of funds). Monetary policy could become more accommodative, provided inflation is in check. Since the nonoil fiscal deficit is already high and the multiplier is low, another massive fiscal stimulus is imprudent. Instead, adjustment in the nonoil deficit should be postponed and automatic stabilizers should be allowed to operate.

B. Medium-Term Outlook

11. Russia still has significant unrealized growth potential. Twenty years after the collapse of the Soviet Union, Russia’s per capita income level stands at only about 40 percent of the OECD average. While growth averaged 5¼ percent during 2000–11, this performance was less than impressive against the background of the output collapse of the 1990s and considering that the price of oil—Russia’s main export—quadrupled over this period.1 The relatively poor performance is closely linked to economic instability, weak policy frameworks, and a difficult investment climate. Large scope for catching up remains.

uA01fig05

Russia: Relative GDP per capita (PPP), 1991-2011

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Source: World Economic Outlook.

12. Current policy plans do not go sufficiently far in reversing the crisis-related stimulus and ensuring economic stability and growth. Unless these weaknesses are forcefully addressed, growth prospects will remain subdued, with real growth projected to fall to 3¾ percent by 2017 in the baseline scenario (Figure 5). Long-term potential growth will be modest—below 4 percent. Inflation will remain elevated at around 6½ percent under unchanged policies. The current account surplus will gradually decline as oil prices stabilize and robust import growth continues.

Figure 4.
Figure 4.

Russian Federation: Monetary Policy, 2008–12

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Central Bank of Russia; and IMF staff estimates.
Figure 5.
Figure 5.

Russian Federation: Selected Economic Indicators Under Three Scenarios, 2005-17 1/

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Russian authorities; and IMF staff projections.1/ Assumptions for the three scenarios are as follows:• Baseline scenario assumes a continuation of current policies. Monetary policy will allow greater exchange-rate flexibility but remain too loose resulting in inflation above the medium-term target. Fiscal policy will implement the 2012-14 medium-term budget, with an unchanged nonoil deficit after 2014. There will be no major changes in banking sector policies. Policy frameworks will remain largely unreformed.• Adverse scenario assumes a permanent external shock, with oil prices declining to $60 per barrel in 2013 and staying there in real terms for the remainder of the forecast. In 2013, fiscal policy responds by maintaining expenditures unchanged in nominal terms at their 2012 level, while monetary policy becomes more accommodative. During 2014-15, the nonoil deficit of the federal government is reduced at the same pace as envisaged in the current medium-term budget for 2013-14, with no further consolidation after 2015, while monetary policy remains neutral. As in the baseline, no progress is made regarding structural reforms and the strengthening of policy frameworks. In 2013, when oil prices drop by about $40 per barrel, the ruble depreciates significantly, but reserves are used to prevent an overshooting of the exchange rate.• Reform scenario assumes full implementation of reforms recommended by the staff. Monetary policy will focus on bringing inflation down to 3 percent over the medium term, amid a flexible exchange rate. Fiscal policy will implement a more ambitious, credible, and growth-friendly consolidation with the nonoil deficit of the federal government declining to the government’s suspended long-term target of 4.7 percent of GDP by 2015. The supervisory framework will be strengthened along the lines recommended by the 2011 FSAP. Fundamental structural reforms are put in place to improve the business climate and competitiveness, and policy frameworks will be strengthened in line with IMF staff recommendations.

13. A continuation of current policies would amplify Russia’s vulnerability to external shocks. In an adverse scenario, a sharp and permanent decline in commodity prices—following, for example, a significant drop in global growth—would put considerable pressure on Russia’s external and fiscal accounts as the economy slows. Over the medium term, investor confidence would be slow to return and capital outflows would continue putting a drag on growth.

14. A strengthening of policy frameworks and decisive progress on structural reforms could lift the medium-term growth rate considerably. The reform scenario envisages higher medium-term growth—around 6 percent—supported by a stronger and more credible fiscal retrenchment, monetary policy taking full control of inflation, a stronger and more competitive financial system, and effective implementation of structural reforms. In this scenario, the short-term drag on growth from fiscal retrenchment would be offset by a more stable and business-friendly economic environment. This would boost investor confidence and support an early return of productive capital inflows. More ambitious policy adjustment would also help build policy space to respond to possible shocks.

External Sector Assessment for Russia1

Staff’s assessment indicates that Russia’s external position in 2011 was moderately weaker than one consistent with medium-term fundamentals and desirable policy settings. The authorities broadly agreed with this assessment but expressed reservations about the methodology.

Regression-based assessment of current accounts as discussed in the External Sector Report suggests that the cyclically-adjusted current account surplus in Russia was 0 to 2 percent of GDP weaker than the level implied by fundamentals and desirable policy settings (current account norm). In addition, model-based approaches point to a modest real exchange rate overvaluation of 0–10 percent.

uA01fig06

Current Account (CA) Assessment for Russia, 2011

(Percent of GDP)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Source: IMF staff estimates based on the External Balances Assessment.

These results are broadly in line with the findings of staff’s cross-country dollar-wage regression, which was introduced in the 2009 Russia staff report to supplement the standard exchange rate regressions by directly comparing the competitiveness of the manufacturing sector across a broad set of countries. For 2011, this fundamentals-based wage approach indicates that the ruble was about 9 percent overvalued.

Fundamentals-based Dollar Wage, 2006-11

article image
Source: IMF staff estimates.

In addition to Russia’s structural factors such as expected population aging and the high dependence on nonrenewable resources, the assessment of the current account and real exchange rate also reflect an important policy gap in Russia. The nonoil fiscal deficit remains significantly higher than its longterm sustainable level (estimated at around 5 percent of GDP). More prudent fiscal policy, as recommended by staff, would result in a larger current account surplus (by about ¾ percentage points of GDP, which is about the half of the estimated current account gap). The increased flexibility of the exchange rate also is appropriate and should help address imbalances.

1 Prepared by Daehaeng Kim

Regional Spillovers from Russia 1

The Russian economy is closely interconnected with the CIS region, mainly via trade, remittances, and policy channels. The sharp contraction of the Russian economy during the 2008/09 crisis affected the region severely, with a significant drop in Russia’s imports from and remittances to the region. A large depreciation of the ruble during the crisis also triggered sharp currency devaluations in most CIS countries, weakening banks’ balance sheets and credit. While Russia’s subsequent recovery has been benefiting the region, Russia’s export ban on cereals during August 2010–June 2011 and the increase in the gasoline export duty to a prohibitive level in May 2011 added to inflationary pressures in the region.

uA01fig07

Imports from CIS Countries, 2001-11*

(Percent of CIS combined GDP)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Central Bank of Russia; and IMF staff calculations.* CIS countries include Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyz Republic, Moldova, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

Imports and remittances have recovered fully from the 2008/09 crisis. Russia’s imports from CIS countries rebounded beyond the 2007–08 levels (over 8 percent of the combined GDP of the region). The Russian markets are particularly important for Belarus, Kyrgyz Republic, and Ukraine—Russia’s imports account for 23–32 percent of these countries’ total exports. Remittances also surpassed the pre-crisis peak, and they remain particularly important for Moldova, Kyrgyz Republic, and Tajikistan, where remittances from Russia are a key source of foreign exchange earnings (15-40 percent of GDP). Given the strong linkages between Russia and other CIS countries, new shocks to the Russian economy would continue to reverberate throughout the region.

uA01fig08

Individual Remittances to CIS Countries, 2007-11

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

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

A global vector auto-regression (GVAR) confirms considerable growth spillovers from Russia to the region.2 The GDP elasticity to Russia’s GDP is around 3 in Armenia and Ukraine, much higher than the elasticity of a combined GDP shock to France, Germany, and the Netherlands. Given the significantly higher Combined shock to Germany, France, and Netherlands. Given the significantly higher volatility of Russia’s growth, Russia will remain the key spillover risk to the region with the “overall spillover risk” from Russia—the estimated GDP elasticity times standard deviation of the growth rates—far higher than that from core EA and comparable to that from the U.S.

uA01fig09

Peak Real GDP Responses to 1 percent GDP Shocks 1/

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: World Economic Outlook; and IMF staff estimates.1/ Peak response of real GDP in percent in a given country to an one percent positive shock to real GDP in Russia, Core EA, and the United States, respectively.2/ Combined shock to Germany, France, and Netherlands.
1 Prepared by Daehaeng Kim 2 For more details, see EUR/MCD Spillover Report-Output Spillovers to the CIS and Baltic Countries, forthcoming.

Post-Election Opportunities

15. The policy discussions focused on how Russia’s new government could put in place the reforms needed to lift growth and diversify the economy. These efforts should focus on reducing fiscal vulnerabilities and limiting the crowding out of private investment, bringing down inflation while allowing a flexible exchange rate, and pushing ahead on structural reforms.

A. Anchoring Fiscal Policy

Russia’s public finances should be anchored on a rule that both delinks the economy from oil price fluctuations and ensures equitable sharing of the oil wealth by all generations. In order to return the nonoil deficit to a level consistent with these objectives, an ambitious medium-term plan should be articulated. In light of the low share of discretionary spending, fundamental public sector reforms will be needed, including in pensions, healthcare and education.

16. Staff and the authorities agreed that continued high nonoil deficits amplify fiscal vulnerabilities and undermine economic stability. At nearly 10 percent of GDP in 2011, the federal government nonoil deficit was more than double the authorities’ (suspended) long-term target of 4.7 percent of GDP that staff sees as equitable across generations, highlighting the extent to which the stimulus provided during 2009–10 has become entrenched. Debt sustainability is not an immediate concern, given the low public and gross external debt levels (below 15 percent of GDP, and about 30 percent of GDP respectively, in 2011).

17. Fiscal policy is procyclical again this year. The 2012 budget implies an increase in the federal nonoil deficit of about 1 percent of GDP, while election campaign promises could add up to another 1½ percent of GDP in 2012 and 6 percent of GDP on a cumulative basis by 2018, on top of an already un-ambitious medium-term budget. At the same time, the Reserve Fund stands at a relatively low level compared to the pre-crisis situation, even after the authorities partially replenished it earlier this year.

Cost of election campaign promises 2012-18

(Percent of GDP)

article image
Source: Sberbank’s Center for Macroeconomic Research
uA01fig10

Percent of potential GDP

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: World Economic Outlook; and IMF staff estimates.

18. In this regard, staff views the medium-term budget as falling short of what is needed to reduce fiscal risks and to ensure intergenerational equity. The 2012–14 budget envisages that the nonoil deficit by 2014 would still be about 9 percent of GDP—only slightly lower than its 2011 level.

19. A more ambitious fiscal consolidation than envisaged in the medium-term budget would reduce overheating pressures as well as vulnerabilities to external shocks. Cutting the deficit by some 1½ percent of GDP in 2012 compared to the 2012 supplemental budget with further consolidation of about 1½ percent of GDP per year through 2015, would reduce demand pressures while rebuilding the Reserve Fund to create a cushion against external shocks. This would require that implementation of campaign promises are offset by fiscal savings elsewhere.

20. There is scope for ample high-quality fiscal adjustment over time. The staff has identified up to 12 percent of GDP in possible measures (text table). The immediate priority should be to withdraw existing crisis-related stimulus, particularly subsidies to enterprises, and reduce tax exemptions.

21. The authorities are planning to adopt a new fiscal rule. The existing budgetary rule targeting a nonoil deficit of 4.7 percent of GDP was suspended as a consequence of the global financial crisis, and the authorities aim to replace it with an oil-price rule, starting with the 2013 budget. The Ministry of Finance recently submitted to the government a proposal for the oil price rule. The rule would include a ceiling on expenditures (oil revenue at the “base” oil price, plus all nonoil revenues, plus a net borrowing limit of 1 percent of GDP), and oil revenues above the “base” oil price would be saved in the Reserve Fund until it reaches 7 percent of GDP—once the Reserve Fund reaches this threshold, at least half of excess oil revenues should go to the National Wealth Fund, while the remaining resources would be channeled to the budget to finance infrastructure and other priority projects. Starting in 2013, the rule will use a 5-year backward-looking average of oil prices as the base, which will gradually increase to a 10-year average by 2018, to avoid abruptly moving to a very low base oil price. The authorities consider that the planned oil-price rule would be easier to communicate than the nonoil deficit rule and would allow for a more gradual transition to a stronger fiscal position. The authorities also added that a more ambitious rule would be politically very difficult to implement. Staff noted that while the precise form of any rule may be less important than political support and consistent implementation, the proposed rule would leave the Reserve Fund below the authorities’ targeted level of 7 percent of GDP—too low to adequately insulate against a large drop in oil prices—and the nonoil deficit in excess of a level consistent with equitable sharing of the oil wealth across generations by 2020 (Box 4), though it would help delink the budget from short-term oil price fluctuations. Staff also emphasized the importance of avoiding excessive use of supplemental budgets to avoid undermining the rule.

Possible consolidation measures

(Percent of GDP)

article image
Source: Ministry of Finance, WB and IMF staff estimates.

Originally part of crisis-related stimulus.

Based on estimtates from the Ministry of Finance for the size of tax expenditures in 2010.

22. Pension reform will be indispensible to achieve the required fiscal adjustment but other measures will also be needed. With discretionary expenditures amounting to only about one-third of total expenditures, durable fiscal consolidation will require structural reforms. This will need to include pension reform, especially in light of adverse demographic trends. Staff projects that, absent reforms, maintaining the current replacement rate of about 40 percent would require substantial increases in public pension spending—from 9 percent of GDP in 2010 to 16 percent in 2050. Recent proposals by the Strategy 2020 working group (an expert group which in late 2011 made proposals for Russia’s economic and development strategy through 2020) aimed at ensuring the sustainability of the pension system—including increasing the retirement age for both sexes to 63 by 2030—go in the right direction, but not far enough. Staff’s advice is to progressively raise the retirement age for both men and women to 63 years by 2030 and 65 years by 2050 (in line with expected advances in longevity), which would allow pension spending to remain broadly unchanged in relation to GDP from its 2010 level while increasing the supply of labor (Box 5). The authorities agreed that pension reform is needed to contain public pension spending and are exploring options, with formal proposals to be put forward in coming months. In addition, the generous eligibility criteria for early retirement should be tightened, while strengthening disability and welfare programs to protect the vulnerable. Means-testing could also help because local governments top up basic pensions to the regional subsistence level and the eligibility criteria are unclear. Other measures, such as better targeting social transfers and improving the efficiency of government expenditures, are also needed to ensure fiscal sustainability.

Authorities’ Response to Past IMF Policy Recommendations

The authorities’ macroeconomic policy adjustment and structural reforms over the past two years have been in the direction recommended by staff, but at a slower pace and a smaller magnitude.

Monetary and financial sector policies

In line with staff advice, the CBR has gradually tightened monetary policy, made important changes to the operational framework to make monetary policy more effective, and prepared for the introduction of inflation targeting. In particular, the CBR started using the repo rate as the main effective policy rate and has taken steps to narrow the policy rate corridor—both measures should strengthen the clarity of the monetary policy signal. In line with long-standing staff advice, the CBR has also continued to make the exchange rate more flexible and interventions have been further reduced. Communications on monetary and exchange rate policy have also improved markedly. On financial sector policies, however, implementation of the recommendations from the 2011 FSAP has been slow as key legislative amendments to expand CBR supervisory authority over bank holding companies and related parties, and the use of discretionally expert judgment (in line with the Basel framework) remain pending before the Duma.

Fiscal policy

The reduction of the federal nonoil deficit back to the authorities’ (currently suspended) long-term target of 4.7 percent of GDP has been slow and has come mainly as a result of higher-than-expected nonoil revenues and expenditure under-execution rather than a concerted effort at rapid consolidation. The Reserve Fund was used to finance the budget deficit in 2009, in line with staff’s advice, but as the economy started recovering in 2010, the Reserve Fund continued to be drawn down to finance the budget deficit. Despite the suspension of the fiscal rule, the authorities transferred most of the higherthan-anticipated oil revenues in 2011 to the Reserve Fund to rebuild buffers as staff recommended. However, the practice of twice-yearly supplemental budgets undermines the fiscal framework.

Structural policies

While over the past several years there have been several policy proposals aimed at attracting investment, diversifying the economy and raising potential growth, implementation has been limited. Russia’s WTO accession, expected to be finalized in mid-2012, is a bright spot which should be leveraged to catalyze the needed domestic structural reforms staff has been recommending such as limiting corruption, strengthening the rule of law, and reducing state interference in the economy.

An Example of the Oil Price Rule in Practice 1

The objectives of a fiscal rule in oil producing countries are two-fold: first to protect the budget—and by extension the economy—from oil price volatility and second to ensure fiscal sustainability by supporting intergenerational equity. Using a nonoil deficit target as derived by a permanent oil income model (POIM) can help ensure that both objectives are met and fiscal reserves are gradually rebuilt—this is discussed in more detail in Strengthening Russia’s Fiscal Framework. The planned oil price rule, on the other hand, has to be supplemented with other constraints, such as a ceiling on borrowing or expenditure, to meet the first objective of delinking the budget from oil price fluctuations, and the base oil price should be set to be consistent with the second objective of intergenerational equity.

The Ministry of Finance has put forward a proposal for a new fiscal rule discussed in paragraph 21.

The planned rule implies that the nonoil balance would decline to 6.3 percent of GDP by 2020 but the overall balance would remain in deficit over this horizon, despite oil prices that are generally lower than the WEO projections for oil prices, with the exception of 2016-18. As a result, the Reserve Fund would remain at a low level that could be insufficient to withstand a prolonged period when oil prices are lower than the base price.

If a more restrictive rule were used where expenditures were limited to oil revenues at a base price of $80 plus all nonoil revenues, the overall level of spending could be maintained constant in real terms over the long term, thereby preserving intergenerational equity. Under such a rule, the nonoil deficit would reach the 4.7 percent level recommended by staff (see Strengthening Russia’s Fiscal Framework) by 2019, the assets in the RF could be augmented further as this rule would generate fiscal surpluses throughout the period to 2020, and the income from these assets would contribute to maintaining constant overall spending in real terms. Indeed, this rule would increase the RF to nearly 6 percent of GDP by 2014.

The following example compares the rule proposed by the Ministry of Finance and the rule that would ensure intergenerational equity.

Oil-Price Rule Examples (percent of GDP, unless otherwise noted)

article image
Source: IMF staff estimates.

expenditures equal oil revenues at base price, plus nonoil revenues, plus 1 percent of GDP net debt financing

expenditures equal oil revenues at $80, plus nonoil revenues

1 Prepared by Charleen Gust.

Pension Reform in Russia 1

Staff estimates (see The Challenge of Public Pension Reform in Advanced and Emerging Economies and Reforming the Public Pension System in the Russian Federation, forthcoming WP) suggest that given projected increases in longevity and relatively low fertility rates, keeping the replacement rate for pensions in Russia at current levels would nearly double public pension spending as a share of GDP, from 9 percent of GDP to 16 percent of GDP by 2050.

uA01fig11

Projected Public Pension Spending in Russia to keep replacement rate at 2010 level

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Rosstat; and IMF staff estimates.

To contain spending, there are three main dimensions along which pension reform can be undertaken: (i) curtail eligibility, mainly by increasing the retirement age; (ii) reduce the generosity of the system (i.e. the replacement rate); or (iii) increase revenues (i.e. raise the contribution rate).

Curtailing eligibility (mainly by increasing the retirement age) is the recommended option. The statutory retirement ages in Russia of 55 years for women and 60 years for men are low in an international context. Gradually equalizing the retirement ages for both sexes to 63 years by 2030 and 65 years by 2050, in line with projected increases in life expectancy could stabilize pension spending at current levels. At the same time, increases in the retirement age should be accompanied by steps to limit early retirement. In Russia, this would mean phasing out the complex system that allows certain occupations and professions to claim benefits early and reduce benefits claimed prior to retirement age to reflect the longer period over which they will be received.

Increasing retirement ages would have many other advantages such as: increasing employment levels; helping avoid a decrease in the replacement rate thus reducing the impact of reforms on elderly poverty; and being potentially easier for the public to understand in light of increasing life expectancies (see Macroeconomic Effects of Public Pension Reforms). By undertaking reforms to put Russia’s pension system on a sustainable footing, pension reform could support the needed fiscal adjustment over the medium to long term in order to ensure an enduring return to a sustainable fiscal position.

Substantial cuts in replacement rates, which are broadly in line with other countries at present, would be undesirable as they would increase old-age poverty. Increasing the payroll tax from its current level of 22 percent of wages to about 30 percent of wages in 2030 and more than 40 percent in 2050, in order to keep pension spending at current levels, would also be undesirable. These levels of contribution are beyond the currently observed payroll rates in other countries—nearly all advanced and emerging economies have pension contribution rates below 30 percent of wages. Such large contribution hikes would have adverse labor market effects and could further promote informality. Such increases would also go against recent efforts of the Russian authorities to reduce the cost of labor.

1 Prepared by Charleen Gust.

B. Tightening the Monetary Policy Stance and Anchoring Low Inflation

After a significant tightening of monetary conditions in 2011, policy has been on hold. Further policy action will be required to keep inflation within the range targeted by the CBR. While recent advances in the operational framework for monetary policy are welcome, further steps are needed to enhance its effectiveness and to anchor inflation at a low level.

23. The monetary stance has become too loose in view of the cyclical position of the economy and continued high core inflation. The CBR tightened monetary policy during 2011, including by gradually steering the interbank market rate from the CBR deposit rate of 2¾ percent in January to the CBR repo rate of 5¼ percent by the end of the year (Figure 4). Since then, however, policy has effectively been on hold. Despite the currently low level of headline inflation, with core inflation still above 6 percent, the output gap closed, and real credit growth in double digits, the risks to medium-term inflation have increased. Including some modest pass through from recent ruble depreciation, headline inflation is likely to bounce back to 6½ percent by the end of 2012. Without policy action, this level would likely be sustained in 2013, thus causing the authorities to breach their end-year inflation targets for 2012 (5-6 percent) and 2013 (4½-5½ percent).

24. At the same time, the CBR has continued to make good progress with the preparations for the adoption of formal inflation targeting. In particular, in line with staff advice over the past year, the CBR has moved from an effective floor system to a more symmetric interest rate corridor system with the repo rate as the de facto policy rate in the middle of the corridor. This transition was aided by an improved fiscal position and a sharply reduced level of exchange rate interventions which allowed for better control of domestic liquidity conditions and interest rates. The CBR has also begun to narrow the corridor so as to limit interest rate volatility. These changes have strengthened the clarity of the monetary policy signal and should help improve the monetary transmission mechanism, paving the way for the CBR’s planned move to formal inflation targeting in 2014.

uA01fig12

CPI Inflation

(Year-on-year)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: Rosstat; and IMF staff estimates.1/ Trimmed-mean core inflation excludes the most extreme price movements on a monthly frequency. It is a good proxy for trend inflation, measured as a centered 24-month moving average inflation rate.

25. The staff argued for a gradual further tightening of monetary policy to keep underlying inflation on a downward path. A monetary tightening, effected by a gradual increase in the CBR repo rate, should reduce core inflation and help to keep headline inflation between 3–5 percent over the medium term—a level regarded as appropriate by staff. Timely policy action to contain the expected rebound in inflation would also be essential to bolster the CBR’s credibility and help anchor medium-term inflation expectations (see Annex III). The authorities conceded that there was a considerable risk that the inflation targets would be missed in 2012 and 2013, but were reluctant to raise interest rates in light of signs of decelerating credit growth, low headline inflation, and the large uncertainties stemming from the euro area financial turmoil.

26. Recent advances in monetary operations are welcome but further steps are needed. In particular, the staff suggested that formally making the repo rate the primary CBR policy rate, in combination with the completion of the narrowing of the policy rate corridor to reduce interest rate volatility, would further enhance the clarity of the monetary policy signal. In addition, a reduction in the number of CBR liquidity instruments and rates would be useful to simplify the framework and encourage interbank lending. Finally, further improvements in communication policies could greatly enhance the effectiveness of monetary policy. In this regard, an important step would be for the CBR to start publishing inflation forecasts. In the staff’s view, timely implementation of these reforms—in combination with enhanced ruble flexibility (see below)—would improve the prospects for a successful move to formal inflation targeting. The authorities had no plans to make the repo rate the primary formal policy rate, and noted that in practice markets were already recognizing it as the key policy rate. With regard to communication policies, they broadly agreed with the staff and noted their intention to strengthen external communications on the inflation outlook, albeit initially without publishing inflation projections.

uA01fig13

Bank Liquidity

(Stock, billions of rubles)

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

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

27. The ongoing steps to further enhance exchange rate flexibility are commendable. In December 2011, the authorities further widened the moving operational exchange rate band from 5 to 6 rubles (some +/- 8 percent around the center of the current band) while further reducing intervention limits. The staff and the authorities agreed that these steps were helping to make the exchange rate more flexible and allow monetary policy to focus squarely on inflation. The staff supported the authorities’ plans to make the ruble even more flexible going forward, noting how ruble flexibility is playing an essential role in absorbing current fluctuations in oil prices.

28. International reserves are adequate and there is no need for further reserve accumulation for precautionary purposes. At end-2011, international reserves amounted to about $500 billion, nearly a quarter of which are savings in the Reserve Fund and National Wealth Fund. The staff noted, however, that the accumulation of fiscal savings in the oil funds should continue as long as oil prices are high. Over time, it would be appropriate to invest oil reserve fund assets in a more diversified portfolio of instruments. The staff also noted that the differentiation in reserve requirements according to residence, which was introduced in 2011, was obsolete in the face of continued capital outflows and could be revoked. The authorities agreed but did not consider revoking the differentiation a priority.

C. The Financial Sector: Containing Risks and Promoting Sound Intermediation by Strengthening Supervision

While Russian banks weathered the 2008-09 crisis and the financial market distress in 2011 relatively well, important gaps in the supervisory framework vis-a-vis international standards, as identified by the 2011 Financial Sector Assessment Program (FSAP), remain. Strengthening the supervisory framework is key to promoting sound financial intermediation that would help underpin investment, growth, and stability.

29. Official liquidity support to banks has shielded the financial system from international financial turmoil. Banks have managed ruble and foreign exchange liquidity risks well, supported by solid deposit growth and their net foreign creditor position. However, tight global liquidity conditions and capital outflows from Russia have reduced external funding for the corporate sector, while the fiscal position and the change in exchange rate policy affected liquidity conditions in the domestic money market. Stepped-up official liquidity operations helped maintain broadly adequate levels of liquidity in the system, ensuring the continued availability of financing to the private sector (Figure 2).

30. The financial system is improving but concerns remain about asset quality in the context of rapid credit growth and volatile oil prices (Table 7). Banks’ overall performance has improved, as indicated by higher profitability (over 2 percent return on assets); lower NPL ratios (which declined from about 10 percent in 2009 to below 7 percent in 2012Q1); and stable ratings despite global turbulence. At the same time, credit growth has picked up, reducing the capital adequacy ratio to 14¾ percent in 2012Q1, partly as the government has not expanded the capital base of state-owned banks since the crisis, and raising the loan-to-deposit ratio. Maintaining credit quality of rapidly expanding loans could be a challenge going forward, as the stock of legacy NPLs remains high.2 Stress tests at the CBR highlight the role of oil prices as a main source of spillovers from global market conditions. The authorities considered nominal credit growth of 20–25 percent per year manageable, especially as part of the growth reflected the corporate sector substituting domestic for external funding. Authorities and staff concurred that rapid growth in household credit warranted vigilant monitoring, notwithstanding the small size of this segment (10 percent of GDP); and, more broadly, saw that strengthening the supervisory framework per the 2011 FSAP recommendations is key to promoting sound financial intermediation.

Table 1.

Russian Federation: Selected Macroeconomic Indicators, 2008–13

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Sources: Russian authorities; and IMF staff estimates

Based on the 2012–14 budget and the 2012 supplemental budget.

Excludes one-off tax receipts from Nanotechnology and Housing Funds in 2009.

In months of imports of goods and non-factor services.

Table 2.

Russian Federation: Balance of Payments, 2008–13

(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 indebtedness of repos by the monetary authorities.

Table 3a.

Russian Federation: Fiscal Operations, 2009–13 1/

(Percent of GDP, unless otherwise indicated)

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Sources: Russian authorities; and IMF staff estimates.

Cash basis. Based on draft 2012-14 budget and 2012 supplemental budget.

Table 3b.

Russian Federation: General Government Stock Positions

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Sources: Government Finance Statistics; and IMF staff estimates.
Table 4.

Russian Federation: Monetary Accounts, 2008–13

(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.

Table 5.

Russian Federation: Medium-Term Framework and Balance of Payments, 2008–17

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Sources: Russian authorities; and IMF staff estimates.
Table 6.

Russian Federation: Medium-Term Framework and Balance of Payments, Reform Scenario, 2008–17

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Sources: Russian authorities; and IMF staff estimates.

Russia team’s working projections, not based on WEO assumptions.

Table 7.

Russian Federation: Financial Soundness Indicators, 2007-12

(Percent)

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

Exposures to Cyprus mostly reflects a state-owned bank’s exposure to its subsidiary in the country.

31. The authorities are improving financial sector supervision. The CBR has created a new financial stability department and now organizes regular stress testing for banks. Separately, the authorities are establishing a new high-level financial stability council to strengthen macroprudential oversight, although its relation to the existing Inter-Agency Working Group to Monitor Financial Market Conditions has yet to be defined.3 The planned adoption of Basel III capital framework implies tightening minimum capital requirements in line with new global standards with a stricter definition of capital and more prudent risk-weights, while maintaining a 10 percent minimum total capital ratio requirement.

32. However, critical legislative changes that address the supervisory framework’s key weaknesses remain pending. The 2011 FSAP identified important gaps in the regulatory and supervisory framework vis-à-vis international standards. In particular, the CBR lacks adequate authority to effectively supervise bank holding companies and related entities, and address connected lending. The CBR also does not have sufficient power to exercise discretion based on its professional judgment in applying regulations to individual banks, which is an important component of the Basel framework. Without these powers, the CBR has limited ability to detect vulnerability and to take adequate supervisory actions; for instance, the CBR has no legal power to request banks to recapitalize after a negative stress test result. Legislation addressing these weaknesses was submitted to the Duma in the spring of 2011, but has yet to be passed. Moreover, the current draft introduces professional judgment only for defining related parties. The staff and the authorities agreed that prompt passing of the pending legislation, which is only a first step towards bringing Russia’s regulatory system at par with international standards, remains a top priority.

33. The supervisory framework for non-bank financial institutions also needs further strengthening. In 2011, the Federal Service for Financial Markets (FSFM) assumed responsibility for insurance and securities market supervision and was given responsibility for supervising cooperatives and microfinance institutions. Staff noted that major legislative changes will be needed to equip the expanded FSFM with basic supervisory powers, including the authority to issue secondary regulation to interpret the law as well as industry-wide binding norms, in line with FSAP recommendations. The authorities indicated that the timeframe for doing so remains uncertain.

D. Improving the Investment Climate

Improving Russia’s investment climate is essential for attracting productive investment and capital inflows, diversifying the economy, and promoting sustainable growth.

34. Russia’s weak investment climate remains an important obstacle to economic diversification and growth. Given adverse demographic trends, productivity improvement—through higher investment and innovation—will have to be the primary source of long-term growth in Russia. This challenge underscores the need for broad reforms to strengthen the business environment which compares unfavorably to peers (Figure 6).

Figure 6.
Figure 6.

Governance Indicators for Selected Countries 1/

Citation: IMF Staff Country Reports 2012, 217; 10.5089/9781475505030.002.A001

Sources: The 2011 World Governance Indicators; and IMF staff calculations.1/ Higher values mean better governance. Indicators range from +2.5 to -2.5.2/ Excluding Russia.3/ For 14 Emerging European Economies.

35. Russia’s WTO accession should be a useful platform for further reforms. Russia’s WTO membership will come into force in mid-2012, after a long journey spanning two decades. WTO membership should be seized upon to strengthen the momentum for domestic reforms to make the business environment more predictable and rules-based, and thereby boost Russia’s long-term growth potential. The experience of other countries suggests that the development of sound domestic institutions is the main determinant of the benefits gained from WTO accession in terms of medium-term development and growth.

36. Expeditious implementation of reform plans already announced will be crucial. Staff broadly agrees on the current reform proposals to strengthen the business climate, including former President Medvedev’s anti-corruption initiatives and “10-point plan,” the government’s privatization agenda, and the recommendations of the Strategy 2020 advisory group. However, actual progress has been limited. More generally, reform efforts to limit corruption, strengthen the rule of law, and reduce the state’s influence in the economy (including through more decisive privatization of state-owned companies) should be prioritized to realize further catch-up gains in productivity and income levels. The authorities confirmed that their long-term economic policy will focus on strengthening the investment climate and regional development, as recently put forward by President Putin’s Executive Order (Box 6).

Long-Term Economic Policy Priorities of the New Government 1

On May 7, 2012, the first day of his new presidency, President Putin issued a Decree on long-term economic policy, focused on investment climate improvement. The government is ordered to take measures to increase fixed capital investment from current 21 percent of GDP to 27 percent, to raise labor productivity by 50 percent and the share of high-tech industries in GDP by 30 percent by 2018. The President also called for an improvement of Russia’s ranking in the World Bank’s Doing Business index from the current 120th place to 20th place by 2018. Among others, the following actions are envisaged by the decree:

I. Submit to the Duma, by October 1, 2012, a draft law on use of oil revenues, including new rules for the Reserve Fund and the National Wealth Fund.

II. Revise by November 1, 2012 privatization plans to include sale by 2016 of all Government stakes in all companies, excluding those in the energy sector, defense enterprises and natural monopolies, and adopt regulations for state-controlled companies to purchase stakes in other companies. By December 1, 2012, companies with more than 50 percent Government share should create and launch programs for selling non-core assets.

III. Analyze by March 1, 2013 the efficiency of state corporations, owing assets in airplane building, ship building, defense and car industries and draft proposals for improving their management.

IV. Significantly reduce by January 1, 2015 the time it takes for businesses to complete procedures (and the costs of such procedures) in some areas of state regulation (construction, connections to utility networks, tax benefits and tax administration, customs).

V. Establish by December 1, 2012 the institution of ombudsman for entrepreneurs’ rights at both the federal and regional levels.

VI. Starting from 2013, introduce compulsory public audits of costs and technologies for all large investment projects with state participation

VII. Introduce by November 1, 2012 a new mechanism of issuing state guarantees for investment projects of medium-sized enterprises in sectors other than mineral extraction and processing.

1 Prepared by Oksana Dynnikova.

Staff Appraisal

37. The Russian economy has recovered from the 2008–09 crisis and is now running close to its potential. High oil prices, strong wage growth, and robust consumption have supported demand. Meanwhile, the unemployment rate and capacity utilization have recovered their pre-crisis levels, suggesting that any remaining slack in the economy is small. The factors recently muting headline inflation are expected to recede in coming months. The external position was moderately weaker in 2011 than one consistent with medium-term fundamentals and appropriate policy settings. The increased flexibility of the exchange rate has been helping absorb external shocks and address imbalances.

38. Ongoing turbulence in international markets is affecting Russia mostly through oil prices. Reliance on oil exports exposes Russia to declining oil prices, especially if accompanied by large capital outflows. While the more flexible exchange rate and the private sector’s reduced external exposure have improved the economy’s resilience to external shocks, significant weaknesses persist. In the event downside risks materialize, the exchange rate should be allowed to operate as the main shock absorber, liquidity should be provided as needed, and the automatic stabilizers should be allowed to operate.

39. Russia still has significant unrealized growth potential but, under unchanged policies, the outlook is for continued moderate growth and a rebound in inflation. The new government has the opportunity to realize this potential and put Russia on a sustainable growth path, while reducing vulnerabilities to shocks. An ambitious fiscal adjustment would help contain demand pressures in the short run, while over time laying the basis for balanced economic growth and equitable spending of oil wealth across generations. Adopting a firm medium-term anchor for fiscal policy should be an integral part of the fiscal strategy. Monetary policy should aim for stable and low inflation, with further monetary tightening needed to keep inflation on a declining path. Exchange rate flexibility should help absorb external macroeconomic shocks. Critically, the new government should deliver quickly on long-awaited structural reforms.

40. The current budget risks overheating the economy and is depleting the wealth of future generations. The authorities should implement an ambitious fiscal consolidation to return the nonoil deficit to about 5 percent of GDP by 2015, which staff estimates would be consistent with intergenerational equity. At the same time, an adequately ambitious fiscal anchor should be reinstated to guide medium-term fiscal policy, decoupling the fiscal stance from short-term variations in oil prices and ensuring the oil wealth is shared across generations. Given the low share of discretionary expenditures in total expenditures, durable fiscal consolidation will need to be underpinned by structural reforms, including pension reform.

41. Monetary policy should be aimed at securing low and stable inflation. Timely tightening of monetary policy is necessary to contain the rebound in inflation and anchor inflation expectations. The greater exchange rate flexibility is welcome as, besides helping absorb external shocks, it allows monetary policy to focus squarely on inflation. For the successful adoption of inflation targeting, continued steps to strengthen monetary policy tools are necessary. In addition, further enhancing communication policies, including the publication of inflation forecasts, will be important to improve transparency and convey the rationale for the CBR’s policy measures to the public. Transparency would also be improved by making the repo rate formally the primary policy interest rate.

42. A stronger supervisory framework is key to facilitating sound financial intermediation. The financial system is improving, but concerns remain about asset quality in the context of rapid credit growth and volatile oil prices. Russia continues to improve its financial stability analyses and macroprudential oversight framework. In this regard, the prompt passing of legislation on consolidated supervision and connected lending, and the expansion of the CBR’s powers to use professional judgment remains a top priority.

43. Delivering on structural reforms will promote economic growth. Structural reforms are crucial to increase investment, diversify the economy, and raise potential growth. Russia’s accession to the WTO should be seized upon to strengthen the momentum for reforms, make the business environment more predictable and rules based, and to resist protectionist pressures. Complementary steps to reduce corruption, strengthen the rule of law, and scale back state involvement in the economy—including through transparent and decisive privatization of state-owned companies—are priorities.

44. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Table 8.

Russian Federation: Indicators of External Vulnerability, 2007−11

(Percent of GDP, unless otherwise indicated)

article image
Sources: Russian authorities; and IMF staff estimates.

Gross debt of general government.

Series discontinued in 2008.

RTS index, end of period.

S&P long-term foreign currency debt rating, end of period.

JPMorgan EMBIG Russia Sovereign Spread.

Table 9.

Russian Federation: Public Sector Debt Sustainability Framework, 2009–17

(Percent of GDP, unless otherwise indicated)

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General government and government-guaranteed gross debt.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r= interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r − π (1+g) and the real growth contribution as −g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Table 10.

Russian Federation: External Debt Sustainability Framework, 2008–17

(Percent of GDP, unless otherwise indicated)

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Derived as [r − g − r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

ANNEX I. Russia: Risk Assessment Matrix1

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ANNEX II. Russia: Key FSAP Recommendations and Implementation

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The authorities are preparing to upgrade the banking resolution framework in line with “Key Attributes for Effective Resolution” issued by the Financial Stability Board at the end of 2011, rather than taking up specific FSAP recommendations.

ANNEX III. Russia: Sensitivity of Inflation Expectations

The effect of exogenous price shocks on inflation generally depends on how well inflation expectations are anchored. If a central bank’s commitment to low and stable inflation is credible, the private sector may expect that it will neutralize the effect of price shocks, so that outer-year inflation projections would likely be less affected than otherwise. In turn, such firmly-anchored inflation expectations would also help the monetary authorities to stabilize inflation with smaller policy adjustments than would otherwise be needed.

The extent to which inflation expectations are anchored can be examined by estimating the response of medium-term inflation expectations to a revision to the near-term inflation forecast, which generally reflects the up-to-date information on factors that affect (or will affect) inflation. Following the methodology used in the October 2011 WEO (Chapter III), we estimate how the consensus views on future inflation (ΔEitπi,t+N) respond to the change in the current period inflation expectations (ΔEit πit) for each forecasting horizon (N = 1 to 5) in a broad set of countries, including Russia. The regression equation is as follows:

Δ ⁢ E i ⁢ t ⁢ π i , t + N ⁢  =  α ⁢  +  β N   ⋅ Δ ⁢ E i ⁢ t ⁢ π i ⁢ t ⁢  +  μ i ⁢  +  λ t ⁢  +  ϵ i ⁢ t

where i and t represent country and year, respectively. The data for this analysis is based on the consensus forecasts for 21 advanced, and 12 emerging market (EM) inflation targeting economies over the past two decades, which provide the average of medium-term inflation projections by various economic institutions twice a year.1 Further, the regression allows for different responses of inflation expectations to positive and negative inflation news, respectively, i.e., βN = γN + θN. d, where d is a dummy variable for negative inflation news.

In Russia, short-term inflation expectations are very responsive to upward inflation news. For example, when the current period inflation projection is revised upward by 1 percentage point, next year’s inflation projection (t+1) is revised by the same magnitude. The sensitivity of inflation expectations to a positive inflation shock in Russia is significantly higher than that in advanced economies throughout the 5-year expectation horizon, and also higher than that in EM peers in the short term (1 year), though the gap there is much narrower and disappears in the medium-term projections (top panels of text chart).

In contrast, Russia’s market expectations on future inflation have hardly responded to downward inflation news suggesting that Russia’s private sector regards a downward inflation shock as transitory, and thus does not adjust even short-term inflation expectations in face of downward inflation news. Such an asymmetry between upward and downward shocks does not exist in advanced economies. And the pattern in Russia is opposite to that found in its inflation targeting EM peers, where forces driving downward revisions to the current period inflation projections are seen as more lasting—i.e., structural gains, while the wider confidence interval implies that cross-country variations are considerable (bottom panels of text chart).

More persistent (and asymmetric) inflation expectations in Russia seem to be a reflection of the weak credibility of the central bank’s commitment to low and stable inflation in the past, which, in turn, appears to have undermined the effectiveness of the monetary policy. Continuing the recent improvement in the central bank’s credibility—and thereby more firmly-anchored inflation expectations—will be key to the success of formal inflation targeting in Russia.

uA01app01fig01
Sources: Consensus Forecasts; and IMF staff estimates.1/ Dotted lines represent 95 percent confidence intervals.2/ EM inflation targeting economies include Brazil, Chile, Colombia, Czech Republic, Hungary, Indonesia, Mexico, Peru, the Philippines, Poland, Thailand, and Turkey.
1

Comparing Russia’s output level today with that of the early 1990s is subject to several measurement problems. For a summary, see e.g. A. Shleifer and D. Treisman “A Normal Country: Russia After Communism,” Journal of Economic Perspectives, Vol. 19 (1)—Winter 2005—Page 151-174.

2

Potential under-reporting and under-provisioning, as examined by the 2011 FSAP stress testing exercises, remain important.

3

This Group, established at end-2010, narrowly focused on defining systemically important financial institutions to be intensively monitored.

1

The RAM shows events that could materially alter the baseline path—the scenario most likely to materialize in the view of the staff.

1

Consensus forecasts update the inflation survey twice a year, March and September. The change in the current period inflation expectations is the revision to the nearest end-year inflation projection between these biannual surveys.

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Cover IMF Staff Country Reports
Russian Federation: Staff Report for the 2012 Article IV Consultation
Author:
International Monetary Fund
Volume/Issue:
Volume 2012: Issue 217
Publisher:
International Monetary Fund
ISBN:
9781475505030
ISSN:
1934-7685
Pages:
60
DOI:
https://doi.org/10.5089/9781475505030.002
Figure 1.

Russian Federation: Production Indicators and Inflation Developments, 2008–12

(Annualized quarter-on-quarter growth rate of seasonally adjusted 3-month moving average, unless otherwise indicated)

Quarterly GDP, seasonally adjusted, and Output Gap

Labor Market Conditions,

(Annualized seasonally adjusted growth)

Current Accout Balance and Capital Flows

(Percent of GDP)

Russia: Ruble Flexibility Versus Euro-Dollar Basket, 2005-12
Figure 2.

Russian Federation: Banking Sector Developments, 2008–12
Figure 3.

Russian Federation: Fiscal Policy, 2004–12

Russia: Relative GDP per capita (PPP), 1991-2011
Figure 4.

Russian Federation: Monetary Policy, 2008–12
Figure 5.

Russian Federation: Selected Economic Indicators Under Three Scenarios, 2005-17 1/

Current Account (CA) Assessment for Russia, 2011

(Percent of GDP)

Imports from CIS Countries, 2001-11*

(Percent of CIS combined GDP)

Individual Remittances to CIS Countries, 2007-11

Peak Real GDP Responses to 1 percent GDP Shocks 1/

Percent of potential GDP

Projected Public Pension Spending in Russia to keep replacement rate at 2010 level

CPI Inflation

(Year-on-year)

Bank Liquidity

(Stock, billions of rubles)
Figure 6.

Governance Indicators for Selected Countries 1/