Russian Federation: Staff Report for the 2015 Article IV Consultation

KEY ISSUES AND RECOMMENDATIONS Context. Growth was anemic in 2014, reflecting preexisting structural bottlenecks exacerbated by geopolitical uncertainty and sanctions. The ruble depreciated for the most part of 2014 and came under severe pressures at the end of the year due to the sharp decline in oil prices and the intensification of sanctions. As a result, inflation accelerated sharply. In response, the shift to a flexible exchange rate was accelerated and monetary policy was tightened significantly. Measures to stabilize the banking system were introduced, including a bank capital support plan. The authorities’ policy response stabilized the economy. However, structural reforms have remained stalled. Near-term macroeconomic policy mix. The fiscal policy stance for 2015 appropriately allows for limited stimulus. Monetary policy normalization should continue at a prudent pace, commensurate with the decline in underlying inflation and inflation expectations. The size of the bank capital support program appears to be sufficiently large, but the parameters of the program should be adjusted to strengthen incentives for banks to seek private capital and reduce cost to the public sector. Medium-term policy challenges. An ambitious and credible medium-term fiscal consolidation program is necessary to adjust to lower oil prices. Changes to the fiscal rule should be considered to support medium-term fiscal sustainability. Boosting potential growth will require implementation of structural reforms. This would include (i) strengthening governance and protection of property rights; (ii) lowering administrative barriers and regulation; (iii) increasing competition in domestic markets; (iv) enhancing customs administration and reducing trade barriers; and (v) improving the transparency and efficiency of public investment procedures. Reinvigorating the privatization agenda, as soon as market conditions permit, would enhance economic efficiency. A deeper and more efficient financial system would improve the allocation of capital thereby enhancing economic growth.

Abstract

KEY ISSUES AND RECOMMENDATIONS Context. Growth was anemic in 2014, reflecting preexisting structural bottlenecks exacerbated by geopolitical uncertainty and sanctions. The ruble depreciated for the most part of 2014 and came under severe pressures at the end of the year due to the sharp decline in oil prices and the intensification of sanctions. As a result, inflation accelerated sharply. In response, the shift to a flexible exchange rate was accelerated and monetary policy was tightened significantly. Measures to stabilize the banking system were introduced, including a bank capital support plan. The authorities’ policy response stabilized the economy. However, structural reforms have remained stalled. Near-term macroeconomic policy mix. The fiscal policy stance for 2015 appropriately allows for limited stimulus. Monetary policy normalization should continue at a prudent pace, commensurate with the decline in underlying inflation and inflation expectations. The size of the bank capital support program appears to be sufficiently large, but the parameters of the program should be adjusted to strengthen incentives for banks to seek private capital and reduce cost to the public sector. Medium-term policy challenges. An ambitious and credible medium-term fiscal consolidation program is necessary to adjust to lower oil prices. Changes to the fiscal rule should be considered to support medium-term fiscal sustainability. Boosting potential growth will require implementation of structural reforms. This would include (i) strengthening governance and protection of property rights; (ii) lowering administrative barriers and regulation; (iii) increasing competition in domestic markets; (iv) enhancing customs administration and reducing trade barriers; and (v) improving the transparency and efficiency of public investment procedures. Reinvigorating the privatization agenda, as soon as market conditions permit, would enhance economic efficiency. A deeper and more efficient financial system would improve the allocation of capital thereby enhancing economic growth.

Context

1. Russia entered 2014 with declining potential growth. Over 2011–14, Russia’s growth decelerated more (relative to pre-crisis performance) than in most other countries and comparator groups. While some of Russia’s growth deceleration is attributable to the stabilization of oil prices, it also reflects stalled structural reforms, weak investment, declining total factor productivity (TFP), and adverse population dynamics.1 In particular, excessive regulation, weak governance, and a large government footprint in the economy have discouraged efficiency-enhancing investment.

A01ufig1

Difference in Real GDP Growth Relative to Pre-crisis

(Percent)

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Source: World Economic Outlook1/ merging and Developing Europe excluding Turkey2/Middle East and North Africa: Oil Exporters3/Latin America and the Caribbean4/Emerging and Developing Asia excl. China and IndiaNote: Each bar represents the difference between the average growth for 2011-2014, and the average growth for 2000-2008.

2. In the second half of 2014, the dual external shock from oil prices and sanctions exacerbated the slowdown. Sanctions triggered a sudden stop as Russian firms’ access to international markets was impaired while geopolitical tensions increased uncertainty and weakened confidence (Box 1). In late 2014, the economy was also affected by the sharp decline in terms of trade due to falling oil prices2. These shocks combined to make growth anemic in 2014 (Figure 1). The growth slowdown in 2014 occurred amidst record-low unemployment, above-target inflation, and an economy operating slightly above full capacity.

Figure 1.
Figure 1.

Russian Federation: Recent Developments

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: World Economic Outlook; Russian authorities; and IMF staff estimates and calculations.

3. The ruble came under severe pressure at end-2014, reflecting the balance of payments shocks from lower oil prices, limited access to international capital markets, and concerns about the large external debt redemptions in December. These led to large net capital outflows (USD154 billion or about 8 percent of GDP, the highest level since 1999–2000) and a significant decline in FX reserves (Figure 2). Also, inflation accelerated sharply following the exchange rate depreciation and Russia’s countersanctions (ban on imports of food products).

Figure 2.
Figure 2.

Russian Federation: Monetary and Financial Developments, 2013–15

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Central Bank of the Russian Federation; Bloomberg; and IMF staff estimates and calculations.

4. Sanctions and market turbulence raised concerns over financial stability (Figure 3 and 4). Prior to the sharp ruble depreciation, banks’ capital and income positions were already deteriorating due to the economic slowdown. The situation worsened in mid-December 2014 as retail deposit outflows created liquidity pressures, asset prices declined and the Central Bank of Russia (CBR) raised policy interest rates, worsening banks’ net interest margins. Finally, the ruble depreciation put pressure on banks’ risk-weighted capital.

Figure 3.
Figure 3.

Russian Federation: Banking Sector Developments, 2008–15

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Central Bank of the Russian Federation; IMF staff estimates and calculations.
Figure 4.
Figure 4.

Russian Federation: Banking Sector Soundness, 2011–15

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

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

5. The authorities took steps to stabilize the financial system and the economy (Box 2). The CBR allowed the exchange rate to float, tightened monetary policy significantly and expanded its FX liquidity facilities. The government introduced an anti-crisis plan, including a 2 percent of GDP bank capital support program, and revised its 2015 budget to reallocate spending to priority sectors.

Impact of Sanctions

The United States (US), the European Union (EU), Japan, Switzerland, and other countries, imposed sanctions against Ukrainian and Russian individuals and entities in response to Russia’s actions in Crimea and developments in Eastern Ukraine.1 In particular, the US and EU sanctions prohibit US and EU persons and transactions conducted in the US and EU that involve providing financing for, or otherwise dealing in new debt with maturity of more than 30 days, by major state-owned Russian banks and energy companies. Sanctions also include a ban on exports of high-technology goods for use in the energy sector. On August 7th, Russia introduced a one year ban and limits on imports of agricultural and food products from countries that imposed sanctions on Russia. Russia and the EU have subsequently extended the duration of sanctions.

Sanctions will impact growth negatively in the short-run via weaker investment and consumption. Model-based estimates suggest that sanctions and counter-sanctions could initially reduce real GDP by 1 to 1½ percent. Prolonged sanctions, could lead to a cumulative output loss over the medium term of up to 9 percent of GDP, as lower capital accumulation and technological transfers weakens already declining productivity growth.

1 Switzerland has taken measures to prevent the circumvention of international sanctions through its territory.

Authorities’ Policy Response

The authorities put together a comprehensive policy package around three main pillars: (i) accelerating the move to a floating exchange rate regime and provision of FX liquidity; (ii) stabilizing the banking system; and (iii) providing some fiscal stimulus while limiting wage indexation in order to contain second-round effects of the depreciation on inflation.

The CBR floated the ruble when market pressures intensified in November 2014 to facilitate a more rapid adjustment to external shocks and curb reserve losses. Subsequently, the CBR raised the policy rate to 17 percent, including by 650 bps on December 16th to limit financial stability risks and respond to a worsening inflation outlook. In addition, the CBR expanded its FX liquidity facilities, as new maturities were added to CBR’s FX auctions and the definition of eligible collateral was broadened. Finally, the government issued a directive requesting five large SOEs to ensure that by March 1st 2015, the size of their net foreign asset holdings is no greater than the level as of October 1st, 2014.1

The authorities introduced temporary regulatory forbearance, a capital support program, and doubled the level of insured deposits to support the banking system, to secure financial stability and avoid a credit crunch. Under forbearance, banks were (i) granted a moratorium on recognizing negative valuation changes for securities portfolios; (ii) allowed to price FX-denominated assets and liabilities at October 1st 2014 exchange rates; and (iii) allowed flexibility in loan classification and provisioning. CBR estimates that regulatory forbearance sheltered bank’s capital position by up to 2 percentage points. The plan is to start lifting the temporary regulatory forbearance in July 2015. Funds initially worth about 2 percent of GDP—Rub 1 trillion from the 2014 Federal Budget and Rub 400 billion from the National Wealth Fund (NWF)—were allocated for the recapitalization of 27 large banks (43 percent of system assets), smaller banks affected by the sanctions and selected regional banks.2 In addition, the CBR undertook to recapitalize the largest bank (Sberbank which accounts for 30 percent of system assets) if needed.

Finally, the government revised the 2015 budget by reallocating expenditures to increase spending on pension and support specific sectors and employment. Additional measures included budget credit to regions, federal credit guarantees, and use of the National Wealth Fund to support systemically important enterprises and banks.

1 This measure would be a Capital Flow Management measure in the institutional view (see The Liberalization and Management of Capital Flows: An Institutional View, IMF, November 2012). Staff assesses that it had limited implications for domestic and BOP stability with no implications on the effective operations of the International Monetary System.2 The capital support program was subsequently reduced to Rub 830 billion, as estimates of capital needs were decreased. Up to 10 percent of NWF’ assets (Rub 400 billion) could be used to capitalize banks for the purpose of implementing infrastructure projects. In addition, up to Rub 300 billion from the NWF could be used to finance real sector projects through Vnesheconombank (VEB), Russia’s Bank for Development and Foreign Economic Affairs.

Recent Developments

6. In early 2015, the economy contracted, the ruble strengthened, and inflation peaked. GDP contracted by 2.2 percent y-o-y (-2.5 percent q/q) in 2015Q1, owing to declining private consumption and investment, and despite rising government spending. The ruble strengthened significantly, supported by higher oil prices, tentative easing of geopolitical tensions, improvements in confidence due to the authorities’ policy response and lower external debt redemptions by Russian corporates. Weekly inflation (annualized) decelerated sharply, suggesting that the impact of the depreciation and countersanctions largely dissipated by May 2015.

A01ufig2

Inflation and Exchange Rate

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Central Bank of Russia: and IMF

7. The external sector adjustment is underway. In the first quarter of 2015, imports declined sharply reflecting both weak domestic demand and expenditure switching due to the ruble depreciation. Export fell with global oil prices but volumes remained broadly constant. External deleveraging continued in the face of limited market access, with external debt falling to USD560 billion at end-2015Q1 from USD730 billion at end-2013. The exchange rate depreciation has moved the real exchange rate towards a level closer to medium-term fundamentals (Annex 2). However, the possible structural implications of sanctions create exceptional uncertainty about assessing the external position.

8. A banking crisis was avoided but weaknesses persist. Higher deposit interest rates and ruble stabilization resulted in an increase in retail deposits from February 2015 and reduced the liquidity pressures the system faced. The 650 bps policy rate hike was accompanied by a temporary drying up of liquidity in the interbank market (Figure 2), which abated after the authorities announced measures to stabilize the financial system. The strengthening of the ruble, improvements in asset prices and declining spreads have reduced pressure on bank capital, which has been further supported by the authorities’ bank capital support program and regulatory forbearance. However, the banks’ profitability has continued to deteriorate as credit growth has declined sharply, interest margins have fallen, and credit quality has deteriorated. The CBR has continued closing banks, most of them very small in size, involved in dubious transactions or excessive credit risk. Since January 2014, the number of banks has declined by about 115 to around 815, with 27 licenses revoked between January–June 2015.

9. Sanctions have forced banks and corporations to deleverage their external debt (Figure 5). Companies have turned to the local market and banks for FX funding given impaired access to international markets. As a result, external debt has been declining. Moreover, the net FX position of banks has remained positive and all sectors have continued to exhibit higher short-term external assets than liabilities (Figure 7). Some corporates have been successful in rolling over part of their external intra-company liabilities.

Figure 5.
Figure 5.

Russian Federation: Corporate Sector Developments, 2008–15

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Central Bank of the Russian Federation; Dealogic; Bloomberg; and IMF staff estimates and calculations.
Figure 6.
Figure 6.

Russian Federation: Selected Macroeconomic Indicators: 2000–20

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Russian authorities; International Labour Organization; Haver Analytics; and IMF staff calculations.
Figure 7.
Figure 7.

Russian Federation: External Position, 2008–15

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Source: Central Bank of the Russian Federation; IMF staff estimates and calculations.

Outlook and Risks

10. A recession is projected for 2015 due to sanctions and the sharp drop in oil prices (Table 1, Figure 6). Real GDP is expected to contract by 3.4 percent in 2015, as real wages and credit growth fall, and private consumption declines. Investment is expected to continue falling due to low confidence and tight financial conditions. Net exports will support growth as imports decline on the back of falling domestic demand and ruble depreciation. The current account balance (in USD) is expected to remain broadly unchanged as a sharp fall in imports and an improvement in the services balance will mostly offset the negative impact of oil prices on exports. In 2015, net capital outflows are likely to remain elevated due to Russia’s limited access to international capital markets. As a result, FX reserves are expected to decline to about USD360 billion (13.6 months of imports). In the baseline, external and public debts remain low and manageable.

Table 1.

Russian Federation: Selected Macroeconomic Indicators, 2008–16

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

Cash basis.

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

WEO through 2011; and Brent crude oil spot and futures prices for 2012-16.

Previously reported as “Taxable oil volume (millions of tons)”

11. The recovery in 2016 will be muted and medium-term prospects are weak. The more competitive exchange rate, increasing external demand and normalization of financial conditions will support the recovery in 2016. However, private consumption and investment are likely to remain subdued as real income growth remains slow, households continue to deleverage, and external financing is constrained. 3 Moreover, unlike in 2008–09, when oil prices rebounded sharply and Russia’s recovery was rapid, staff’s medium-term projection is based on persistently low oil prices, suggesting a muted recovery. Coupled with the lingering effects of sanctions, negative population dynamics and slowing productivity due to the lack of structural reforms, this is expected to result in weak potential growth in the medium term (around 1.5 percent).

12. Inflation should decline rapidly over the next two years. The recession in 2015 is expected to open an output gap of about 1 percent of potential GDP.4 This, together with the dissipating one-off effect of the exchange rate depreciation in late 2014–early 2015, the recent ruble appreciation, and the partial public wage indexation, will set the stage for inflation to fall to about 12 percent at end-2015 and close to 8 percent at end-2016.

13. An increase in geopolitical tensions is the main risk to the outlook. The baseline scenario is predicated on the absence of additional external shocks. However, an escalation of geopolitical tensions could create additional balance-of-payment pressures and a significant deterioration in confidence. The ruble could depreciate as capital outflows surge and inflation would increase further. Elevated uncertainty would cause investment to contract and precautionary savings to increase further, putting additional downward pressure on domestic demand. The ensuing contraction in economic activity would have a negative effect on the fiscal position and could create additional capital needs for banks.

14. But other risks also cloud the outlook (Annex 3). Lower and/or more volatile oil prices could further dampen the economic outlook. In addition, the positive effect from a more competitive exchange rate is likely to be limited should the authorities pursue inward-looking policies. Although most corporations have enough cash on hand to finance their external debt coming due over the next 1-2 years, and have natural hedges due to energy exports, rapid deleveraging could entail reducing investment, which if sustained would further affect potential output. Possible spillovers from Ukraine could also adversely affect Russian banks, although they have already reported large provisioning against their Ukrainian exposure. A faster-than-expected end to sanctions, while positive, would pose some macroeconomic challenges, as Russia could face large and volatile capital inflows.

15. Against these risks and uncertainties, Russia has large buffers (Figure 7). Russia has a positive and large net IIP (18 percent of GDP), a sizable current account surplus of 4.5 percent of GDP in 2015, low public debt and no need to access international markets for government financing in the short term due to the Reserve Fund (RF) buffer. In addition, while access to international capital markets has been impaired, Russian companies are expected to gradually regain access, as sanctions are lifted. Moreover, the CBR’s reserves remain adequate but could be increased somewhat to reflect Russia’s vulnerability to tail risks stemming from commodity-price shocks and the heightened level of uncertainty related to sanctions.5 Finally, balance-sheet currency mismatches are low and do not limit exchange rate flexibility. Thus, existing buffers reduce the likelihood of a systemic event.

16. Sizeable outward regional spillovers from Russia are unfolding (Figure 8, Box 3). However, the Russian authorities’ policy response, which stabilized its economy, helped to mitigate outward spillovers. Despite this, Commonwealth of Independent States, Ukraine and Baltic countries, closely linked to Russia mostly through trade, remittances and FDI channels, are facing significant spillovers. Eastern Europe’s links to Russia are generally weaker though for some countries’ trade and FDI exposures are still significant (Bulgaria, Serbia, Hungary, Czech and Slovak republics). Some Western European countries, such as Austria and Cyprus, have direct financial exposures to Russia but trade links, beyond energy, are limited.

Figure 8.
Figure 8.

Exposures to Russia, 2014

(or the latest available)

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

1/ Gas exporters to RussiaSource: IMF staff estimates and calculations.

Authorities’ Views

17. The authorities are more optimistic about Russia’s growth prospects but broadly agreed with staff’s risk assessment. The Ministries of Finance (MoF) and Economic Development (MED) expect the contraction in economic activity to be milder in 2015 and forecast positive growth of about 2.5 percent in 2016.6 In their assessment, the more competitive real exchange rate and the bank capital support program will have a larger impact on growth than staff estimates. Moreover, they believe that with the stabilization of confidence and rapid decline in inflation, real income growth will be higher and lead to an earlier and faster recovery in private consumption. Their medium-term outlook envisages higher potential output growth (at around 2.5 percent) than staff’s (at around 1.5 percent), as they expect import substitution to deliver higher investment growth. However, they recognized that this will require implementing structural reforms. They underscored the risks of long-lasting sanctions and lower oil prices, and emphasized the importance of preserving and rebuilding buffers. The authorities remain committed to deepen Russia’s links to CIS countries and Asia, and recognized that a long period of sanctions against Russia may disrupt further integration to the world economy.

Regional Spillovers

In the face of sharply lower oil prices and geopolitical tensions, Russia has entered into a recession. This has resulted in significant spillovers to many Commonwealth of Independent States (CIS), Ukraine and Baltic countries. The spillovers to Eastern Europe have been more limited. The degree of impact is commensurate with the level of countries’ trade, remittances, and FDI links to Russia.

Trade, remittances, and FDI are the main channels of economic spillovers from Russia to neighboring countries, particularly the CIS (Figure 8). Belarus, Lithuania, Ukraine and Turkmenistan have the largest share of exports to Russia (over 9 percent of GDP). The remittances channel is particularly prominent for CIS oil importers, which are among the most remittance-dependent economies in the world. In 2014, remittances constituted close to 20 percent of GDP in Armenia, 24 percent of GDP in Moldova, 30 percent of GDP in the Kyrgyz Republic and 45 percent of GDP in Tajikistan, mainly sourced out of Russia. The FDI channel is also important for a number of CIS countries (Armenia, Belarus, Moldova, and Tajikistan), Bulgaria and Montenegro. The financial sector channel is more limited, given the relatively small presence of Russian banks, although exchange rate depreciations have impacted local banks, especially in highly dollarized economies.

The negative spillovers have contributed to sizable downward revisions to growth forecasts across the CIS. In particular, for Belarus, Moldova, and Caucasus and Central Asia (CCA) oil importers, adverse spillovers from Russia’s recession in 2015 account for more than 2.5 percentage points of the downward growth revision relative to April 2014 forecast. For CCA oil exporters, negative spillovers from Russia contributed to about 1.4 percentage point of the downward revision in the growth forecast. The slower medium-term growth in Russia is expected to negatively impact the medium-term outlook of both CIS and Baltic countries.

Currencies of most CIS countries depreciated (or were devalued) sharply relative to the US dollar following the ruble’s depreciation (in some cases accompanied by large interventions), reflecting confidence effects and expected decline in foreign currency inflows from Russia. Countries with significant trade and remittance links to Russia experienced larger currency depreciation. Rising dollarization in the region, particularly in the CCA countries, where the share of dollar deposits rose to around 60 percent in most countries, points to weak confidence and expectation of devaluations. At the same time, the sharp depreciation of the ruble and the appreciation of the US dollar (to which some CIS currencies are pegged) have put upward pressure on nominal effective exchange rates.

Policy Discussions

The difficult economic conditions require a prudent macroeconomic policy response, especially in view of the elevated external risks. Thus, the discussions focused on (i) providing a limited fiscal stimulus in the context of needed medium-term fiscal consolidation; (ii) bringing inflation down to target over the medium term while avoiding overly tight conditions in the short term; (iii) ensuring financial stability; and (iv) advancing structural reforms that can leverage the more competitive exchange rate to rebalance growth.

A. Fiscal Policy: Short-term Stimulus, Medium-term Consolidation

18. Parliament approved a new 2015 federal budget based on more realistic oil prices and macroeconomic assumptions. Under the new budget, the non-oil deficit is expected to deteriorate by 2 percentage points of GDP compared to 2014, (excluding the one-off bank capital support program). Compared to the initial budget, nominal spending was cut slightly, despite higher inflation in 2015, in an effort to recognize the new economic reality of lower oil prices and economic slowdown. Spending was re-allocated to priority areas such as support to the manufacturing sector (in line with the anti-crisis plan) and social payments, while some programs were cut by 10 percent, and public wages were only partially indexed to inflation. The budget also included limited tax cuts (about 0.2 percent of GDP). It assumes gross financing from the RF of about Rub 3 trillion (4 percent of GDP) in 2015, reducing considerably fiscal buffers for the future.

A01ufig3

Composition of Federal Spending

(Percent of total budget spending)

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Ministry of Finance and staff estimates.

Federal budget

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The 2014 budget included Rub 1000 billion for the bank recapitalization program.

19. Staff supported a slightly expansionary fiscal stance for 2015. The structural non-oil deficit of the general government (federal and regional governments, and extra budgetary funds) is expected to deteriorate by 0.4 percent of GDP, as the federal stimulus is expected to be offset by ongoing consolidation at other levels of government (Table 4). Fiscal policy would thus appropriately provide some stimulus given cyclical considerations, available fiscal space and a measured normalization of monetary policy, while partial wage indexation would support the disinflationary process. However, this may understate the ultimate level of fiscal stimulus as quasi-fiscal stimulus will be provided through the National Wealth Fund and the issuance of guarantees. Staff recommended that the use of quasi-fiscal operations should be limited and coordinated to avoid an overly stimulative fiscal stance.

Table 2.

Russian Federation: Balance of Payments, 2012–20

(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.

WEO through 2011; Brent crude oil spot and futures prices for 2012-16.

Table 3.

Russian Federation: External Financing, 2012–20

(Billions of U.S. dollars)

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Sources: Central Bank of Russia; and IMF staff estimates.
Table 4.

Russian Federation: Fiscal Operations, 2012–20 1/

(Percent of GDP, unless otherwise indicated)

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Sources: Russian authorities; and IMF staff estimates.

Cash basis.

WEO through 2011; and Brent crude oil spot and futures prices for 2012-14.

Balances reflect staff estimates based on projected oil savings.

20. However, staff noted that medium-term fiscal consolidation is required to adjust to lower oil prices and rebuild buffers. Assuming the maximum spending allowed under the federal fiscal rule, staff expects some stimulus in 2016 followed by fiscal consolidation, as the impact of lower oil prices is only gradually captured by the fiscal rule and therefore expenditures.7 This consolidation path would result in a relatively large non-oil primary deficit (almost 7 percent of GDP) and a low Reserve Fund buffer (only 1.0 percent of GDP) by 2020 (Figure 9, Table 4). Indeed, these deficits are above medium-term benchmarks estimated by staff which take into consideration intergenerational equity (Box 4). Reaching these benchmarks would entail additional adjustment, relative to the baseline, of 2–3 percent of GDP over the medium term. Accordingly, a limited fiscal adjusment could begin in 2016. Ultimately, the pace of fiscal consolidation may need to be adjusted to protect the nascent recovery or in the event of a more prolonged or protracted recession.

Figure 9.
Figure 9.

Russian Federation: Fiscal Policy, 2000–20

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Russian authorities; and IMF staff estimates and calculations.

21. Staff cautioned that current rigidities create a challenge to achieving fiscal adjustment. In particular, the application of the fiscal rule and pension indexation could make it difficult to achieve the necessary fiscal adjustment. Under the fiscal rule, the oil price benchmark is a backward-looking average, thus requiring only a gradual consolidation despite the expected persistence of the oil price shock. This could be exacerbated by the conversion of benchmark revenues into rubles using a much depreciated exchange rate.8 Furthermore, full indexation of pension benefits (to 2015 inflation) could permanently increase spending by about 1.1 percent of GDP in 2016, which would need to be offset by reducing other spending to comply with the fiscal rule.

22. Staff recommended changes to the fiscal rule to help support medium-term fiscal sustainability. In particular, staff discussed a menu of options to improve two operational aspects of the rule: (i) increasing the pace of adjustment of the oil price benchmark to allow for a more timely fiscal adjustment; and (ii) gradually raising the amount of savings generated by the fiscal rule to a surplus of 1–2 percent of GDP, as the projected non-oil primary deficits are above the medium-term benchmarks estimated by staff which take into consideration intergenerational equity (Box 4). Improvements along these two dimensions could be made without a significant reform of the principles governing the fiscal rule. Other changes to the fiscal rule could also be considered such as (i) expressing the rule in terms of minimum savings instead of maximum spending to focus the policy debate on savings; (ii) including a limit on spending growth, to avoid pro-cyclical fiscal policy when there is a revenue windfall; and (iii) adjusting non-oil revenues to the economic cycle, and using potential GDP to calculate net financing. However, adjusting for the economic cycle is complicated and subject to great uncertainty, as cyclically adjusted balances are often revised ex post due to revisions to potential GDP.

23. Detailed fiscal measures will also be critical for the credibility of the consolidation program. In particular, a reform of the pension system could deliver substantial fiscal savings over time. Other possible areas for fiscal consolidation include (i) better targeting of social transfers; (ii) reducing energy subsidies; and (iii) cutting tax expenditures. Fiscal consolidation should safeguard public investment, education and health care spending while improving the efficiency of capital budgeting to increase returns on public investment.

Possible Fiscal Adjustment Measures

(Percent of GDP)

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Source: Ministry of Finance, WB, IMF staff estimates

Authorities’ Views

24. The authorities agreed with the need for medium-term fiscal consolidation. In their view, the recent oil price decline should be treated as permanent, requiring fiscal adjustment based on permanent measures. They believed that a balanced budget by 2018 would be consistent with medium-term fiscal sustainability and are considering tightening fiscal policy by limiting spending starting in 2016. They also recognized the challenges created by the current fiscal rule and pension benefit indexation. In that context, the authorities agreed that there is a need to revisit the fiscal rule and welcomed the set of possible modifications suggested by staff.9 Following the workshop on pension reform delivered by IMF experts in March, the authorities are seeking politically feasible reforms to ensure the system’s viability. They argued that a combination of fewer early retirement benefits, and an increase and equalization of statutory retirement ages would bring about a significant improvement in the pension system’s balance.

Russia’s Fiscal Rule1

Resource-rich countries face two important fiscal challenges: (i) conducting a prudent fiscal policy consistent with the long-term value of their resource wealth; and (ii) managing the impact of short-term resource-revenue volatility. The recent sharp oil price decline has exacerbated these challenges. Having an appropriate fiscal framework helps to manage these challenges, reduces “Dutch disease” effects, and limits the risks of large and disruptive adjustments in the future i.e. fiscal sustainability risks.

Russia introduced an oil-price based fiscal rule in December 2012, but it could be further improved. Under the rule, the oil-price benchmark is set as the minimum of (i) a backward-looking moving average of up to ten years of Urals oil prices (USD/barrel); and (ii) a three-year backward looking average. The fiscal rule could be modified to: (i) allow for a faster adjustment in fiscal policy in response to oil-price developments; and (ii) generate more savings as Russia’s current and projected non-oil primary deficits are larger than suggested by typical long-term fiscal benchmarks. Improvements along these two dimensions could be made without a significant reform of the principles governing the fiscal rule.

In particular, the oil price benchmark could adjust more rapidly to developments in the oil market. To adjust more rapidly to perceived changes in the long-term price of oil, the calculation of the oil-price benchmark could usefully include future oil prices, as is done in other countries such as Mexico and Mongolia. An alternative to including future oil prices could be to convert revenues to rubles using an exchange rate that is more consistent with the oil price benchmark, instead of the projected exchange rate (as was done in the past) i.e. the projected exchange rate assumes lower oil prices than the oil price benchmark. However, determining the appropriate exchange rate for conversion is complicated by the fact that (i) the ruble has not been floating until recently; (ii) the level of the exchange rate reflects a number of non-oil factors, including inflation differentials and, recently, the impact of sanctions against Russia. Furthermore, converting revenues using such an exchange rate could complicate communications with the public and markets, as the exchange rate used to convert revenues would be different than the projected one.

The fiscal rule could generate more savings to safeguard intergenerational equity. Estimates of long-term fiscal benchmarks consistent with intergenerational equity points to a federal non-oil primary deficit (NOPD) in the range of 3-4.5 percent of GDP. Generating such NOPDs could be achieved by changing the “net financing” of 1 percent of GDP allowed under the fiscal rule, which increases the maximum level of spending and the deficit, to “net savings” of 1–2 percent of GDP.

1 For more details, see the Selected Issues Paper “Russia’s Fiscal Framework and the Oil Price Shock.”

B. Monetary Policy: Measured Normalization

25. The CBR initiated an easing cycle, introduced changes to its FX facilities and set up an FX purchase program (Figure 2). Since the end of January, the CBR started unwinding the December 16th emergency rate hike, reducing its policy rate by 550 bps. Banks have relied primarily on the FX repos to ease dollar funding pressures in the interbank market and support a smooth external deleveraging. In March 2015, the CBR started to increase the cost of these facilities as the FX market normalized. In May, the CBR suspended the 1-year FX repo facility and announced a program of daily FX purchases of between USD 100–200 million.

26. In staff’s view, the ongoing monetary policy normalization is appropriate and should continue at a prudent pace. The acceleration in inflation (y-o-y) over December 2014–April 2015 reflected, to a large extent, the one-off impact of the ruble depreciation and countersanctions. Thereafter, disinflation should be driven by the recession underway, the stabilization of the ruble, and partial wage indexation in the budget. Therefore, a gradual reduction in the policy rate, commensurate with the decline in underlying inflation and inflation expectations, would be appropriate. In addition, if the authorities implement a tighter budget in 2016 than assumed by staff, this could support a faster normalization of monetary policy. Nevertheless, there are a number of factors arguing for a prudent pace of monetary easing including the uncertainty over the external outlook, the potential for second-round effects given the magnitude of the exchange rate depreciation (Box 5), and the CBR’s need to build credibility under the recently introduced inflation targeting regime. As inflation expectations appear to be mainly adaptive, surveys of inflation expectations should be used cautiously in assessing underlying inflation (Figure 10). Finally, the easing of policy rates should be conditional on a reduction in external and financial stability risks.

Figure 10.
Figure 10.

Russian Federation: Inflation Expectations, 2009–15

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: 1/ Central Bank of Russia and Public Opinion Foundation Survey; 2/ Russia Economic Barometer.

Exchange Rate Pass-through1

Exchange rate fluctuations can have a significant impact on the evolution of inflation and inflation expectations. As such, central banks should carefully estimate the exchange rate pass through to inflation. This is difficult in the case of Russia because nominal exchange rate fluctuations have been relatively limited in the recent past. Therefore, exchange rate pass through to consumer prices has been estimated using data for emerging markets. The analysis suggests that:

  1. The size of the exchange rate fluctuation matters. In particular, a larger exchange rate depreciation tends to lead to a greater impact on inflation (a larger exchange rate pass through). For example, the typical exchange rate pass through in emerging markets is estimated at 20 percent after 12 months. However, the pass though increases up to 45 percent after 6 months when the depreciation is greater than 20 percent.

  2. Episodes of depreciation are associated with greater exchange rate pass through than episodes of appreciation. In particular, the estimated pass through during periods of depreciation is five times greater than during episodes of appreciation.

  3. Inflation-targeting countries typically have lower pass through. However, this result holds only in countries where the central bank has built sufficient credibility to anchor inflation expectations.

Given these results, the CBR should be careful when normalizing monetary policy. First, the ruble depreciated significantly in late 2014-early 2015, suggesting that the inflation pass through was large and relatively fast. Second, the recent appreciation of the ruble, while helpful in bringing inflation down, may not produce a large disinflationary effect. Third, introducing flexibility in the exchange rate regime is often accompanied by higher-than-normal volatility, hence it is important for the CBR to establish credibility by anchoring inflation and inflation expectations under the new regime.

1 For more details, see the Selected Issues Paper “Exchange Rate Pass-through to Inflation. Is Russia Different?”

27. Staff agreed that the changes to the FX liquidity facilities and the introduction of an FX purchase program were broadly adequate. The normalization in the FX interbank market and the end of large FX debt redemptions called for a repricing and rationalization of these facilities. The central bank could consider limiting further the FX allotments to ensure that the facilities remain sufficient for emergency purposes. The pre-announced daily FX purchase program to build precautionary buffers would help guard against tail risks presented by the exceptional external conditions, given Russia’s limited access to international capital markets and vulnerability to commodity shocks. However the strategy should be strengthened by indicating the time-frame the central bank expects to be conducting these operations, thereby avoiding an open-ended policy that may be misconstrued as targeting an exchange rate level.

Authorities’ Views

28. The authorities agreed that monetary policy normalization should proceed at a cautious pace. The CBR noted that the exchange rate pass-through was greater and faster than expected but that disinflationary pressures are now firmly in place given the latest inflation readings, the ruble appreciation and partial wage indexation. As a result, the CBR expects inflation to come down to about 12–14 percent by the end-2015 and between 5.5–7.5 percent by end-2016, provided there are no additional shocks. This should allow further easing to avoid an overly tight monetary stance. The CBR concurred with staff that the pace of interest rate normalization should be cautious and viewed its inflation target of 4 percent as realistically achievable by 2017.

29. The CBR believes there is a need to rebuild reserve buffers. They argued that given the exceptional circumstances and uncertainty regarding the external outlook, there is scope to increase reserves, especially given the evolution of the ruble in the first half of the year. The CBR indicated that the goal of the new FX purchasing program is to rebuild precautionary buffers. They agreed with staff that it was critical to ensure that the program is not seen as targeting a specific exchange rate and noted that they remain committed to the floating exchange rate regime. The authorities also indicated that the parameters of the FX facilities would be adjusted according to market conditions.

C. Financial Sector: A Tailored Policy Response

30. The banking system is facing challenging times (Figure 3). The sector reported after-tax losses in December 2014 and during the first five months of 2015. At end-April, the sector’s reported capital was comparable to a year ago, at 12.9 percent, owing to capital support from the NWF and the government (Rub 236 billion) and regulatory forbearance. Non-performing loans (NPLs) have increased by only 1.5 percentage points to 8.0 percent compared to April 2014 (Figure 4), again helped by regulatory forbearance.

31. Staff acknowledged that anti-crisis measures helped stabilize the banking system. The acute ruble depreciation in December caused regulatory compliance challenges due to the impact on risk-weighted assets from the revaluation of FX-denominated assets. The forbearance measures insulated prudential reports from the depreciation and helped avoid regulatory triggers. The strategy was appropriately combined with intensified supervision, although staff noted that it should be strengthened by increasing transparency with regards to asset quality to improve market confidence. Moreover, staff argued for the prompt elimination of forbearance, along with the implementation of the capital support program, to avoid the emergence of additional financial stability risks in the medium term.

32. The size of the capital support program appears to be sufficiently large (Box 6). Although profitability and capital will continue to be under pressure, recent CBR’s stress tests suggest that the government support for all the large eligible banks—before owners’ mandatory contribution—is sufficient to cover loan-loss provisioning and market losses under an adverse scenario (including an increase in NPLs to 18 percent). However, staff noted that the capital support should be better tailored to the specific needs of individual banks and based on stress tests that are sufficiently conservative, instead of being arbitrarily set at 25 percent of a bank’s total capital.

Features of the Government’s Bank Capital Support Program

In December 2014, the government launched a Rub 1 trillion1 (1.2 percent of GDP) bank capital support program. The main features of the program as of mid-June 2015 are:

Eligibility: The program targets three categories of commercial banks: (i) Banks with at least Rub 25 billion in capital – 27 banks meet this requirement (excluding Sberbank).2, (ii) Banks that are directly or indirectly affected by economic sanctions; and (iii) top regional lenders (up to 13 banks).

Type of capital support: Under the program, the DIA offers government bonds (OFZ) in exchange for banks’ subordinated Tier 2 debt and, for (partly) state-owned and sanctioned banks, in exchange for Tier 1 debt and preferred shares. The subordinated debt should be remunerated above the OFZ rate, but below market rates. Support is set at 25 percent of a bank’s total capital, irrespective of current or prospective capital needs, if any.

Conditions: Banks receiving support must be in full compliance with CBR’s prudential requirements at the time of the capital injection. With the exception of (partly) state-owned banks, banks must raise their own funds equal to at least 50 percent of the government’s support. Owners’ contributions can be in the form of retained earnings over the duration of the subordinated debt. Other conditions include increased monitoring, a commitment to increase credit to selected sectors by 1 percent monthly for three years, and a three-year ban on increasing management salaries and the overall wage bill of the bank. Failure to comply with these conditions would result in penalties that worth up to 2 percent per year of the capital support.

Procedures: Eligible banks, other than regional banks, had until June 1, 2015 to accept DIA’s offer and the process should be finalized by November 1, 2015. Thereafter, the CBR performs a due diligence to verify that banks are in compliance with the program conditions. Onsite asset quality reviews are performed at banks that have not had an onsite supervisory inspection in the preceding 12 months. In the event that a bank does not meet all the program conditions, remedial actions need to be implemented. Finally, requests for support are subject DIA board approval.

In addition to the government’s capital support program, up to 10 percent of the assets of the NWF (0.5 percent of GDP) could be used to support bank’s financing of large infrastructure projects. NWF financing would be provided through subordinated deposits or purchases of subordinated debt with a maturity of up to 30 years. Resources from the NWF would be on-lent by banks (with the lending rate equal to the financing costs from the NWF). Finally, the CBR has been authorized to support Sberbank with subordinated credits (deposits, loans, bonds) amounting to up to 100 percent of its capital, if needed.

1 The program has subsequently been reduced to Rub 830 billion as estimates for capital needs have been reduced.2 Sberbank also meet this requirement but is excluded from the program as it is majority-owned by the CBR. Eight of the 27 banks are partly state-owned, with total capital amounting to 64 percent of the group.

33. However, staff recommended adjustments to the program to minimize the cost to the public sector:

  • Tighter eligibility criteria. Only banks identified ex ante as systemically important should be eligible, while allowing weak non-systemic banks to be resolved in an orderly fashion.

  • Higher cost of capital, to ensure stronger efforts by banks to seek private capital before resorting to public funds. Given that markets are not currently functioning properly, the cost could be benchmarked against historical and/or international experience for similar capital instruments. This would create incentives to repay the government support, as soon as banks regain access to capital markets. Finally, when requiring the private sector to co-finance the capital injection, the authorities should aim at achieving a level playing field between private and partly state-owned banks.

  • Eliminate credit growth targets as forced lending could increase credit risks and potential inefficient credit allocation. While the capital support may facilitate credit growth, credit underwriting should best be based on banks’ commercial assessment of risk and remuneration.

34. Staff noted that the bank resolution framework has been upgraded, but further work is needed to fully address past FSAP recommendations (Annex 4). Legislation adopted in late December 2014 revokes, replaces and consolidates into one law the General Bank Insolvency Law and the 2008 Temporary Law for resolution of banks posing a threat to financial stability. The new law makes notable improvements, such as (i) more timely exchange of information between the DIA and the CBR on failing institutions; (ii) mandatory imposition of losses on shareholders prior to the use of public funds provisions; (iii) greater powers to sanction managers of failing institutions; and (iv) provisions for the bidding procedures of the assets and liabilities of a failed bank. However, staff noted that the new legislation does not provide for a number of tools contemplated in the Key Attributes for Effective Resolution Regimes, including the powers to use a bridge bank and to bail-in all unsecured uninsured liabilities. Finally, staff recommended that supervision of banks heavily dependent on CBR liquidity should be stepped up, including by requesting funding and liquidity plans that makes their business model independent of CBR support.

Authorities’ Views

35. The authorities believe the package was key to stabilizing confidence in the banking system and avoiding a credit crunch. The authorities acknowledged the need for a timely lifting of forbearance and plan to start eliminating these measures in July 2015. They emphasized that capital support provided to banks was aimed at supporting credit growth rather than to cover losses. In their view, this justifies the large number of eligible banks, the relatively low cost of capital, and the requirement that banks increase lending. The authorities also noted that the list of systemically important banks is still under discussion and is expected to include a number of regional banks in addition to the 19 banks already supervised by CBR’s SIB unit. The risk to public funds is seen as minimal as capital support is only granted to banks after CBR’s inspection. Furthermore, the wage bill restrictions are considered to be a sufficient incentive for banks to seek private sector capital. The authorities agreed that private capital would have been preferable, but argued that even if greater incentives were in place, it would be difficult to attract capital given the sanctions. The authorities agreed that over time they should reconcile the current bank resolution framework with the Key Attributes.

D. Structural Policies: Re-invigorate the Reform Agenda

36. Structural challenges have slowed potential growth. Adverse population dynamics have contributed to the decline in the labor force, while low statutory retirement ages have reduced workers’ incentives to extend their working life. Administrative barriers, high regulation, weak governance (including perceptions of corruption and weak property rights protection), and poor infrastructure have limited investment and growth (Figure 11).10 The significant presence of state-owned enterprises (SOEs) in key sectors of the economy has also made it difficult to increase competition and efficiency. Several new anti-crisis initiatives aimed at supporting different sectors through subsidies, guarantees, restrictions on the participation of foreign producers in public procurement, and import substitution-like polices, have introduced additional distortions which will put a drag on growth. Finally, the banking system is highly concentrated, lacks depth, and is inefficient at channeling savings to investment.

Figure 11.
Figure 11.

Russian Federation: Russia Faces Structural Problems, 2014

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Sources: Global Competitiveness Report; Transparancy International; and Ease of Doing Business Report.

37. Effective implementation of a structural reform agenda is needed to boost growth. There is an excess of savings over investment in Russia, as evidenced by its large current account surplus. How to retain these savings and channel them into efficient investment is paramount. Improving governance and the protection of property rights, and increasing competition in domestic markets would contribute to improving investors’ confidence, increasing output in the non-energy tradable sector, and attracting investment. Specific reforms that could be introduced in the short term include: (i) strengthening mechanisms to protect property rights; (ii) enhancing customs administration, reducing trade barriers and promote trade; (iii) empowering the Federal Antimonopoly Service (FAS) to eliminate entry barriers to several sectors/markets; and (iv) ensuring mandatory public technology and price audits of all major investment projects with government participation. A deeper and more efficient financial system would improve the allocation of capital thereby enhancing economic growth (Box 7). The privatization program should be revamped as soon as market conditions permit, and SOEs should be managed on a commercial basis. Reforms related to OECD accession should be rekindled despite the suspension of accession talks. Finally, pension reform, especially increasing the statutory retirement age, could increase future labor supply and potential growth.

Authorities’ Views

38. The authorities broadly agreed with the diagnosis and noted their commitment to implement structural reforms. They noted that sanctions and adverse terms of trade are affecting potential growth, on top of pre-existing structural bottlenecks, hence the need to accelerate structural reforms. They see pension reforms as important to increase labor force. The authorities noted that improving property rights, revamping transport infrastructure and enhancing competition in goods and services markets is needed to improve the business climate and boost investment. Moreover, the authorities remain committed to support the manufacturing sector through various programs, ensuring effective support for SMEs. In addition, the MED will continue implementing its reform agenda based on roadmaps, including in the following areas: reducing trade barriers, facilitating the acquisition of construction permits, and improving access to electricity. The Ministry of Agriculture will implement several programs where they see significant scope for efficiency gains and import-substitution.

Russian Banking System and Growth

Russia’s financial sector is analyzed through the lenses of a broad-based measure of financial development (FD).1 Financial development is defined as a combination of depth (size and liquidity of markets), access (ability of individuals to access financial services), and efficiency (ability of institutions to provide financial services at low cost and with sustainable revenues, and the level of activity of capital markets).2

Russia’s financial markets (FM) are found to be relatively developed but financial institutions (FI) lag behind in terms of efficiency and depth. Russia’s FD index (0.58) is higher than the average EM (0.37) and slightly lower than the average BTICS (0.64), a group of countries composed of Brazil, Turkey, India, China, and South Africa. Nonetheless, the components of the index show large disparities between levels of development of FM versus FI. Russia scores much higher than the comparator groups for FM developments as it features higher degrees of access and efficiency in the operations of its financial markets. Although the depth of financial markets is slightly lower than BTICS countries, it remains much higher than the average EM. Nonetheless, along the dimension of FI, Russia lags behind both comparator groups in terms of efficiency and depth while access to financial institutions is about the same.

Intermediation and efficiency are hampered by the structure of the banking system. With some 850 banks operating, the Russian banking system is highly concentrated at the top, and fragmented at the bottom. The top three banks (state-owned) accounted for more than 50 percent of total sector assets at year-end 2014 while the top 20 banks accounted for 75 percent of total sector assets. Lending is highly concentrated among the top 10 bank groups making about 850 banks contribute only 15 percent of total lending. Some indicators of efficiency, including lending-deposit spreads, are close to the average observed in comparator groups. However, most other indicators of efficiency, in particular non-interest income to total income and overhead costs to total assets, show that the banking system is much less efficient in its operations than comparator countries. In addition, concentration indices point to a moderate concentration on the deposit side.

Financial development dividend could be large. Estimates suggest that annual growth could increase by an average of 1 percentage point should Russia move to the maximum level of the FI index. Policies towards this outcome include reducing banking sector fragmentation through consolidation via the continuation of the policies of increased supervision, and tightening capital standards via the adoption of Basel III standards. In addition, strengthening the role of credit bureaus and collateral registries to reduce information asymmetries could foster and improve credit allocation. Finally, the authorities should consider removing interest rate rigidities, in particular by allowing deposit rates to adjust freely while designing in parallel an incentive mechanism that prevents predatory bank lending.

A01ufig4

Financial Development Index

(2013)

Citation: IMF Staff Country Reports 2015, 211; 10.5089/9781513502441.002.A001

Access.FME: FM Efficiency. Source: IMF staff calculations.
1 For more details, see the Selected Issues Paper “Fostering Financial Contribution to Growth.” The analysis focuses on supply factors that could foster financial contribution to growth. Demand factors are beyond the scope of this study.2 Sahay et al. (2015). “Rethinking Financial Deepening: Stability and Growth in Emerging Markets.” Staff Discussion Note No. 15/8 (Washington: IMF).

Staff Appraisal

39. The Russian economy is in a recession in 2015 due to lower oil prices and sanctions. The external position will remain challenging due to deleveraging in the face of limited market access. Growth should resume in 2016 due in part to the authorities’ policy response and higher oil prices. However, the recovery is likely to be hampered by unaddressed structural bottlenecks and adverse population dynamics, leading to weak medium-term growth prospects.

40. Staff welcomes the authorities’ policy response to stabilize the economy. However there remain significant uncertainties regarding oil prices and geopolitical risks. Given these risks, the macroeconomic policy stance must remain prudent.

41. The short-term fiscal stimulus in the 2015 budget is appropriate but medium-term consolidation is required. A slightly expansionary fiscal stance is adequate for 2015 given cyclical considerations and available fiscal space. However, the use of off-budget measures—investment by the NWF and issuance of guarantees—should be coordinated to avoid an overly stimulative fiscal stance. Fiscal consolidation is required over the medium term to adjust to lower oil prices, rebuild buffers and safeguard intergenerational equity. The needed fiscal adjustment should protect public investment, education and health care spending, and could be anchored by revisiting the fiscal rule. In addition, it should be accompanied by permanent and credible fiscal measures which could include (i) pension reform, (ii) reducing energy subsidies, and (iii) better targeting social transfers.

42. Monetary policy normalization should continue at a cautious pace. The dissipating one-off effect of the exchange rate depreciation in late 2014–early 2015, the economic contraction, the partial wage indexation in the 2015 budget, and the recent ruble appreciation will support disinflation. However, the pace of easing should be commensurate with the decline in underlying inflation and inflation expectations. External risks, the potential for second-round effects, and the central bank’s need to build credibility call for cautious monetary easing. The normalization in the FX interbank market and the end of large FX debt redemptions appropriately led to an adjustment of the parameters of FX liquidity facilities, but limiting allotments could be considered. The FX purchase program to rebuild precautionary buffers is understandable but an open-ended policy should be avoided to prevent the perception that the CBR is targeting a specific exchange rate level.

43. The anti-crisis package comprising temporary forbearance and public support has been successful in stabilizing the banking system. The forbearance strategy was appropriately combined with intensified supervision, but should be strengthened by increasing asset-quality transparency to further improve market confidence. The size of the capital support program appears to be sufficiently large, but support to individual banks should be tailored to their specific capital needs. Furthermore, the parameters of the program should be adjusted to strengthen incentives and reduce cost to the public sector. Forbearance should be lifted promptly by end-2015 along with the implementation of the capital support program.

44. Despite progress in improving the bank resolution framework, additional steps should be considered to better align the new legislation, over time, with the Key Attributes for Effective Resolution Regimes, including the powers to use a bridge bank and to bail-in unsecured uninsured liabilities.

45. Boosting medium term growth requires re-invigorating the reform agenda. Avoiding global de-integration, improving governance and property rights protection, increasing competition in domestic markets, reducing the government’s footprint in the economy and limiting regulations remain crucial to foster efficiency, confidence and investment. Initiatives in these areas would also be critical to support the non-energy tradable sector and diversify the economy. In addition, pension reform would help improve labor force dynamics in the face of negative demographic trends. Finally, financial deepening and a more efficient banking system are needed to support long-term growth.

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

Table 5.

Russian Federation: Monetary Accounts, 2012–20

(Billions of Russian rubles, unless otherwise indicated)

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Sources: Russian authorities; and IMF staff estimates.

Data calculated at accounting exchange rates.

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