Russian Federation: Selected Issues

This Selected Issues paper describes structural reform policies in Russia in the last 15 years. There is evidence of a gradual convergence of Russia's performance to that of more advanced economies, though significant gaps remain. Progress in Russia's global competitiveness index indicators during the past 10 years has been generally stronger for those indicators in which Russia's performance was comparatively weaker in 2006. The authorities' view that oil prices will be persistently low and a real exchange rate more aligned to fundamentals should serve as incentives to build a less oil-dependent growth model. Clear targets, carefully sequenced actions, appropriate accountability, and frequent monitoring could help advance reforms.

Abstract

This Selected Issues paper describes structural reform policies in Russia in the last 15 years. There is evidence of a gradual convergence of Russia's performance to that of more advanced economies, though significant gaps remain. Progress in Russia's global competitiveness index indicators during the past 10 years has been generally stronger for those indicators in which Russia's performance was comparatively weaker in 2006. The authorities' view that oil prices will be persistently low and a real exchange rate more aligned to fundamentals should serve as incentives to build a less oil-dependent growth model. Clear targets, carefully sequenced actions, appropriate accountability, and frequent monitoring could help advance reforms.

Structural Policies in Russia: A Medium Term Perspective1

A. Introduction

1. This paper describes structural reform policies in Russia in the last 15 years. In line with IMF(2014a), structural reform policy actions are defined as those aimed at improving or strengthening a country’s environment to conduct sustainable economic activity or its competitiveness, through the strengthening of market-based incentives in product, service, labor, trade, capital and financial markets. Adopting a medium-term perspective is important as structural reforms require consistent implementation and take time to mature. Taking an encompassing approach is also important as economic reform does not usually occur in isolation of other institutional and social reforms. This is in line with the way that a number of institutions evaluate cross-country business environments or competitiveness (including the World Economic Forum (WEF), the World Bank, or the European Bank of Reconstruction and Development). Policy actions aimed at structural reforms in Russia are identified through an analysis of policy statements, as well as other official documentation.

2. In turn, the paper explores the impact of structural reform policies by analyzing Russia’s progress in indicators tracking cross country competitiveness. This is done by analyzing Russia’s performance in the indicators surveyed by the WEF in its Global Competitiveness Index (GCI) Database for the period 2006–15. The paper examines whether the pace of reform is affected by external shocks and the political cycle. It also proposes a simple indicator of policy actions, and looks at its relationship with changes in GCI indicators. Particular attention is placed at the existence of convergence of Russia’s GCI indicators to those of better-performing countries, in particular those in the OECD. In this regard, the paper explores how the pillars of Russia’s competitive advantage evolved through time. Although this analysis does not constitute a formal evaluation of government policy actions, it provides some intuition as to whether structural policies had a positive impact in GCI indicators, which are widely used for international comparisons. In turn, this allows organizing some thoughts about the agenda going forward.

3. The paper is organized as follows: Section II provides a description of the domestic and international context during the last 15 years, while Section III describes the authorities’ views on reform, their diagnostics on challenges, and policy actions. Section IV broadly analyzes Russia’s reform performance, and offers some thoughts on the reform agenda going forward. Section V summarizes the main messages.

B. The Context

4. The period 2000–15 can be split considering both domestic and external developments

and the timing of policy actions. Many of the policy actions can be better understood as a reaction of the context in which they were implemented. Concretely, external factors include the oil price super-cycle, the global financial crisis and external sanctions. Domestic factors mainly include the economic cycle. The use of these criteria results in 5 sub-periods:

• 2000–03: A period characterized by state-building efforts, relatively high levels of poverty, and memories of the unstable 1990s still fresh. The economy is completing its recovery from the 1998 crisis, amidst low but increasing oil prices. Stabilization proceeds but positive results are perceived to be linked to better terms of trade. GDP recovers about 40 percent of what was lost in 1990s, unemployment rates decline and the social situation stabilizes. Russia is invited to the G-8, and the process of WTO accession begins to take shape. From an institutional perspective, the period is characterized by state-building efforts after the instability of the 1990s, including building a coherent framework for the relations between the federal and regional governments. The IMF program expires.

• 2004–07: Aggregate demand grows at double-digit rates. Higher and increasing oil prices multiply social programs, some of which grow at double digits in real terms. Increases in income per-capita result in a decline of poverty rates of close to 50 percent. By 2007, Russia is among the top 10 largest economies. The high oil price triggers a review and change of the functions of the Reserve Fund, and the creation of the National Well-Being Fund. The government’s policies aim to develop the state, improve the public administration and the business climate, and reform the political and judicial system. There is a strong drive to increase population growth through family support policies.

• 2008–10: The global financial crisis results in a sudden-stop of external financial flows and a fall in oil prices. The authorities refocus their priorities to diversify the economy. Policy actions are aimed at establishing areas for economy modernization and increasing efficiency, including in energy, transportation, nuclear technologies, IT, space and telecommunications, medical equipment, pharmaceuticals, agriculture, and military modernization. Continued attention is given to improving the business climate, reducing administrative barriers, and a privatization program is announced. Government programs are maintained and spending levels (in US$-terms) increase despite the decline in oil prices (Figure 1).

• 2011–13: Oil prices recover to pre-crisis levels. Attention is given to the need to reduce administrative barriers to private investment and combat corruption. The authorities aim to increase the middle class by 25 percent and develop professional communities of medical, teachers, scientists and cultural workers. Russia joins the WTO.

Figure 1.
Figure 1.

Federal Budget

(12-month moving sum, billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 230; 10.5089/9781498362856.002.A001

• 2014–15: New oil price shock and conflict in Eastern-Ukraine. The authorities renew their efforts at economic diversification as low-oil prices and external sanctions are perceived as long-lasting. Government spending (measured in US$ terms) decreases for the first time in the new century (Figure 1). The nominal anchor of monetary policy changes from the exchange rate to inflation. The real exchange rate (RER) depreciates significantly for the first time since the 1998 crisis.

C. The Authorities’ Views on Reform and Policy Actions

5. The authorities have generally identified the right challenges facing Russia. Table 1 presents a broad overview of the authorities’ views on structural reform needs organized around the three categories and 12 pillars defined in the WEF’s Global Competitiveness Index (GCI) database. 2 These were identified from a review of official statements, in particular the annual Presidential Addresses over the last 16 years (GoR, 2000-15).3 The authorities identified the main issues to be:

Table 1.

Russian’ Authorities Ideas on Reform and Diagnostics

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Source: IMF staff on the basis of Russian official statements in GoR (2000-15).Note: In parenthesis the year of the Presidential Address where the statement was made.
  • Burdensome administrative barriers and governance problems.

  • Negative demographic trends and infrastructure-driven bottlenecks.

  • Insufficient market competition, in part due to a large footprint of the state in the economy.

  • Lack of economic diversification exposing the economy to terms of trade swings.

To address these issues, the authorities persistently refer to the need to strengthen property rights, tackle corruption, reform public administration, increase market competition, strengthen the business climate, and implement policies to diversify the economy out of oil, among other.

6. Structural reform-related actions have been implemented simultaneously in various fronts, but at times appeared somewhat reactive. Table 2 presents a “heat map” for policy actions organized around the pillars of the GCI database, for the time periods defined above, together with changes in Russia’s relative position vis-à-vis other countries in the sample (in percentile terms), since 2006. These actions are defined loosely as efforts to design, modify or implement legislation, regulations and policies aimed at structural reform. All actions are considered, regardless of whether they achieved their intended outcome or not.4 Against a benchmark in which earlier reforms are focused in strenghtening basic requirements (Pillars 1-4) and proceed gradually to strenghten efficiency (Pillars 5-10), and then innovation (Pillars 11-12), (as recommended by IMF, 2013), policy actions in Russia appear to have been somewhat reactive to changing international and domestic conditions, rather than have followed a consistent blueprint for reforms.

Table 2.

Heat Map for Russia’s Policy Actions and Changes in GCI Pillars

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Source: IMF staff calculations; Global Competitive Index and Database created and compiled by World Economic ForumNotes:Dark Green: Strong policy action (left); strong positive change in GCI (right)Light Green: Moderate policy action (left); moderate positive change in GCI (right)Yellow: Weak policy action (left); moderate negative change in GCI (right)Red: Almost absent policy action (left); strong negative change in GCI (right)

7. Sustained policy action across the whole period is observed in relation to institutions, health and basic education, market size, and innovation. On Institutions (Pillar 1), actions aimed at improving the protection of property rights, reducing red-tape, strenghtening public administration, simplifying dispute resolution procedures between the state and the private sector, increasing the state’s effectiveness, and fighting corruption, among other.5 On basic health and education (Pillar 4), policies aimed at improving demographics trends, and strengthening and making pre-primary and primary education more easily available, also in part to promote population growth. On market size (Pillar 10), actions were aimed at economic integration, in particular with CIS countries (including through the creation of the Eurasian Economic Union), and by efforts to join the WTO. On innovation (Pillar 12), the main actions aimed at strengthening research institutions, promoting the collaboration between industry and universities, and improving the match between labor market needs and university programs, among other.

8. In turn, actions on other fronts are concentrated in specific periods. For instance, efforts at improving infrastructure (Pillar 2) were significant in 2004-07, but less so in 2000-03, 2008-10 and 2011-13. Actions aimed at strenghtening higher education and training (Pillar 5) and technological readiness (Pillar 9), are mainly concentrated in 2008-10 and 2011-13. In turn, actions geared at improving business sophistication (Pillar 11) are mainly concentrated in 2004-07 and 2014-15.

9. Most importantly, the prioritization and timing of policies seems linked to the authorities’ views on the oil price cycle. The authorities regarded the relatively high oil prices in early 2000s (as compared to late 1990s), as temporary, while by 2007 the high oil prices were perceived as persistent and part of a “new international reality”. By 2014-15, low oil prices are again perceived as a persistent shock to which the country needs to adjust.6

10. Accordingly, the pace of reform implementation appears associated with oil price fluctuations. Table 3 shows that 2-year improvements in GCI indicators (in percentile terms) are positively associated with decreases in oil prices, suggesting some cyclicality in reform implementation.7 Moreover, increases in oil price volatility are negatively associated with reforms, suggesting that policy implementation paused somewhat in periods of higher volatility until it became clear whether observed oil prices were persistent. Both the coefficient for oil price fluctuations and oil price volatility are statistically significant and robust to alternative regression specifications. Initial conditions are also positively and statistically significantly associated with reforms, suggesting ‘convergence’ of Russia’s GCI indicators, an issue that will be further discussed below. The election cycle appears not to have a robust association to reforms and it is not statistically significant.

Table 3.

Change in Russia’s GCI Indicators and the Oil Price Cycle

(Stacked 2-year percentile change of 114 GCI indicators for 2008 - 2015)

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Source: IMF staff calculations; Global Competitive Index (GCI) Database compiled by World Economic ForumNote: White heteroskedasticity-consistent standard errors and covarianceCoefficient statistically Significant at 1 percent (*); at 5 percent (**); at 10 percent (***)

11. The economic cycle, in large part linked to oil prices, also influenced policy actions. The cycle affected the timing of structural actions on the macroeconomic front (Pillar 3) and on financial market development (Pillar 8). Although the need to diversify the economy appears very frequently in the authorities’ statements, it is given a higher priority at times of negative output gaps and lower oil prices, which resulted in actions aimed at improving market efficiency (Pillar 6), labor market efficiency (Pillar 7), technological readiness (Pillar 9), business sophistication (Pillar 11), and innovation (Pillar 12).

12. In line with lack of progress in some areas there is a call for more effective action. A number of times the authorities’ statements recognize lack of progress as one of the challenges to overcome (Table 1). This is particularly the case on the need to advance administrative reform, increase transparency, reduce the footprint of the state in the economy, increase market competitiveness, improve the business climate, and promote economic diversification, among other.

D. Achievements and Challenges

Achievements: Russia Gradually Closing Competitiveness Gaps with the OECD

13. Gradual convergence of Russia’s GCI indicators to those of more advanced economies is an achievement. Table 4 shows that the improvement of Russia’s GCI indicators in the period 2006-15 was generally largest for those indicators whose levels (in absolute terms), were the weakest in 2006. Convergence is preserved when percentiles (rather than absolute values) are used, namely GCI indicators (in percentile terms) also improved the most, on average, for those in which their initial percentile was weaker.8 The regression coefficient when using percentiles is larger than that when using absolute values, suggesting either that Russia’s absolute improvement in some indicators was larger than that for other countries; or, that Russia’s weak progress (or absolute deterioration) in some indicators was coupled with weaker progress or a larger deterioration of those indicators in other countries in the sample.

Table 4.

Convergence of Russia’s GCI Indicators

(Change in absolute and relative levels, 2015 vs. 2006)

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Source: IMF staff calculationsNote: White heteroskedasticity-consistent standard errors and covariance Coefficient statistically Significant at 1 percent (*); at 5 percent (**); at 10 percent (***)

14. Early work towards OECD accession may have contributed to the observed convergence.9 Figure 2 shows that, with the exception of innovation (Pillar 12), Russia’s position improved in all pillars (in absolute terms) with respect to OECD averages (as it has more generally improved relative to the average of all countries in the sample). Russia’s GCI indicators (in percentile terms) also broadly improved the most for those indicators which performed the worse vis-à-vis OECD averages in 2006 (Figure 3). In particular, convergence is stronger with respect to OECD countries than with respect to all countries, as reflected by a larger regression coefficient (Table 5). This is partly explained by an increase in the dispersion of performance in OECD countries for most indicators in 2015 vis-à-vis 2006 (Figure 4). However, when Russia’s initial conditions are interacted with the average number of policy actions per indicator per pillar (as shown in Table 2), the resulting coefficients are not always significant, providing evidence that some actions were more effective than others.

Figure 2.
Figure 2.

Russia’s Competitiveness

(Abs. level diff., 2015 vs. 2006; above 45 degree line = better)

Citation: IMF Staff Country Reports 2016, 230; 10.5089/9781498362856.002.A001

Source: IMF staff and Global Competitive Database.
Figure 3.
Figure 3.

Convergence of Russia’s GCI Indicators

(With respect OECD averages, 2006-15)

Citation: IMF Staff Country Reports 2016, 230; 10.5089/9781498362856.002.A001

Source: IMF staff and Global Competitive Database.
Table 5.

Convergence of Russia’s GCI Indicators Relative to the OECD

(Percentile change of 114 GCI indicators with respect to OECD average 2015 vs. 2006)

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Source: IMF staff calculations; Global Competitive Index Database compiled by World Economic ForumNote: White heteroskedasticity-consistent standard errors and covarianceCoefficient statistically Significant at 1 percent (*); at 5 percent (**); at 10 percent (***)
Figure 4.
Figure 4.
Figure 4.

Competitiveness: Russia vis-à-vis OECD

(Global Competitive Indicators, in percentiles; 1 = best)

Citation: IMF Staff Country Reports 2016, 230; 10.5089/9781498362856.002.A001

Source: IMF staff calculations and Global Competitiveness Index Database
Challenges: Large Competitiveness Gaps Remain

15. Despite convergence, Russia continues to compare unfavorably with respect to OECD averages in most GCI indicators. Table 6 shows that 50 percent of the GCI indicators improved significantly with respect to OECD averages since 2006, 23 percent remained about unchanged and the remaining deteriorated. However, large initial gaps have not been completely closed and thus the distribution (in percentile terms) of Russia’s performance across GCI indicators in 2015 has remained similar to that in 2006, with less than 20 percent of such indicators at levels similar or higher than those of the OECD averages, and about 70 percent of them at levels that are lower than the OECD average by more than 20 percentage points. In particular, relative improvement (of between 5 and 20pp) in a number of indicators was more the consequence of OECD averages worsening rather than Russia’s absolute performance improving, including on “property rights” and “intellectual property protection”, where Russia’s performance falls in the sample’s lowest 10th percentile in 2015.

Table 6.

Russia’s GCI Indicators vis-à-vis OECD Average

(Level in 2015, and relative change in the period 2006 - 15; in percent over 114 indicators)

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Source: Global Competitive Index Database and IMF staff calculations

16. Moreover, Russia’s relative strengths and weaknesses with respect to OECD countries have remained broadly unchanged in the last 10 years. Russia’s competitive edge is associated with its market size (Pillar 10), relatively flexible labor markets (Pillar 7) and macroeconomic performance (Pillar 3). Indeed, according to measures of market size, Russia compares significantly above the OECD average; for labor market efficiency, Russia is close to the OECD average, and better than second and third-tier performers among OECD countries. 10 Regarding measures linked to the macroeconomic environment, Russia compares shy above the OECD average, mostly due to its low public debt levels. With respect to infrastructure (Pillar 2), Russia compares slightly below the OECD average, and similarly to second-tier performers among OECD countries. In turn, Russia’s relative performance is the weakest in market competitiveness (Pillar 6), business sophistication (11), and innovation (12). Figure 4 shows that in all of these, Russia compares worse than all OECD countries including those with the weakest intra-group performance.11

17. Particularly challenging are indicators where Russia still compares unfavorably with respect to OECD averages, and which have stayed unchanged or worsened since 2006.

Table 7 shows relatively low (and unchanged) levels with respect to OECD averages for “efficiency of legal framework in challenging regulations”; “strength of auditing and reporting standards”; “quality of roads”; “intensity of local competition”; “effect of taxation on incentives to work”; and, “capacity to retain and attract talent”, among other. In addition, indicators showing relatively low (and worsened) levels relative to OECD averages include “quality of the education system”; “degree of customer orientation”; “availability of latest technologies”; “firm-level technology absorption”; “FDI and technology transfer”; “local supplier quantity and quality”; “production process sophistication”; “capacity for innovation and company spending on R&D”; “strength of investor protection”; and, “state of cluster development”, among other.

Table 7.

Russia GO Indicators vis-à-vis OECD Averages

(Relative Levels in 2015 and Relative Change in Levels, 2006 - 2015)

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Source: IMF staff calculations; Global Competitive Index Database compiled by World Economic ForumNotes:First figure refers to Pillar; second figure to Russia’s percentile in 2015; third figure to OECD average percentile in 2015; and fourth whether Russia’s level vis-à-vis OECD average, e.g. a move from “very low” in 2006 to “low” in 2015 would be represented by “1 step up” Indicators in Bold refer to those that achieved best position in 2015 (the latest data point)Indicators in red correspond to “Basic Requirements” (Pillars 1-4); in blue to “Efficiency Enhancers” (Pillars 5-10); and Green to “Innovation” (Pillars 11-12)
Russia’s Structural Reform Agenda Going Forward

18. Lower oil prices and a real exchange rate (RER) that is more aligned with fundamentals create the right incentives to advance structural reforms. The authorities’ view that oil prices will be persistently low and the associated realignment of the RER should serve as strong incentives to reinvigorate the structural reform agenda to find a less oil-dependent growth model. Adapting to better relative prices will require effective action in areas where Russia still lags OECD countries (many of which have seen only limited progress in the past 10 years), in part due to some cyclicality in policy implementation. Effective actions are needed to strengthen institutions (increasing the effectiveness of government spending, further reducing administrative burden, protecting investors’ rights; Pillar 1); 12 foster market competitiveness (increase the intensity of market competition, make customs procedures more efficient, Pillar 6); technological readiness (facilitate technology transfer and absorption through FDI and the availability of latest technologies, Pillar 9); business sophistication (increasing the breadth of value chain and the availability and quality of domestic suppliers -all of which will require further localization of production-, including through cluster development, Pillar 11); and, innovation (support university-industry collaboration and research universities, Pillar 12). Progress in these areas should also support productivity increases (Kyobe, 2016). Better leveraging Russia’s current competitive advantage on macroeconomic conditions, labor market flexibility, and market size will also be important.

19. Increasing domestic market competition (Pillar 6) is essential. The gaps of Russia’s GCI indicators in this area with respect to OECD averages continue to be large, while simultaneously significant progress was observed for a large number of non-OECD countries in the past 10 years. Improvements will require identifying the true extent of the footprint of the state in the economy (which should also result in advances in transparency, and lay the ground for an increase in government effectiveness, and accounting standards, Pillar 1). Most importantly, it should result in a carefully designed, phased and transparent divestiture program of non-strategic commercial entities. This would apply to the more than 20,000 commercial entities in which the state has a stake and for which there is no sufficient information about performance (IMF, 2014b).

20. Continue to leverage Russia’s large market size will require firms to adapt to lower RER levels, as well as further trade integration. Firms’ incentives to adapt will be increasingly strong provided macroeconomic policies ensure that the RER remains aligned to fundamentals, and as delinked as possible from fluctuations associated with the oil price super cycle. This should allow entrenching recent gains in the share of local products in domestic consumption. As production localization is related with the availability of economies of scale, firms will have to re-evaluate the trade-off between available varieties and volumes, and adapt varieties to a lower ratio between nominal per-capita income and prices of locally-produced tradable goods. 13 The availability of scale economies should also be supported from further trade integration. Russia (a WTO member since 2012, and of the Eurasian Economic Union, EEU), only has free trade agreements with nine CIS countries, Serbia, and recently Vietnam. This compares unfavorably with the trade integration (including through global value chains) that is observed in other emerging economies, in Latin America (e.g., Chile, Mexico), or Asia (e.g. South Korea, ASEAN economies).14

21. Fiscal consolidation in response to lower long-term oil prices is needed to preserve Russia’s macroeconomic edge (Pillar 3). Fiscal consolidation should support keeping Russia’s favorable position relative to OECD countries on macroeconomic issues, as it would contribute to maintain low public debt-to-GDP ratios, decrease long-term inflation, and preserve RER levels close to economic fundamentals. Regarding the latter, delinking oil price fluctuations from government spending will contribute to RER stability and provide the right price signals to firms in the tradable sector, and to workers alike.

22. However, fiscal consolidation should not impact negatively on other competitiveness dimensions. If fiscal consolidation relies on tax policy changes, these should affect the least possible incentives to invest or to work (in order not to affect market and labor market competition), or deteriorate income distribution (which would likely affect human capital formation). Increasing the progressivity of personal income taxes or taxing luxury consumption and of social “bads” may increase revenues without unduly affecting competitiveness. Improving tax administration, reducing evasion and tax expenditures could also help.15 Gradual progress in pension reform should contribute both to fiscal consolidation and to support labor supply.16

23. In particular, Russia’s fiscal spending in basic and advanced education, health (Pillars 4 and 5), and economic infrastructure (Pillar 2) should be preserved. Absolute performance for these pillars has improved for a large number of countries in the last 10 years (Figure 5). Thus, decreases in spending in these areas are more likely to result in swift decreases in Russia’s relative competitiveness.17 This is compounded by the fact that Russia still maintains a negative gap with most OECD countries on basic health and education indicators (which constitute the core of human capital formation), and infrastructure, where needs are pervasive (in particular for roads, where Russia’s corresponding GCI indicator falls in the lowest 10th percentile in 2015). Lower oil fiscal revenues will make institutional reforms to attract private capital into infrastructure a priority, including through public private partnerships (PPP). Reporting obligations under PPPs and other major and multi-annual contracts should improve transparency on this instrument and gradually increase its use (IMF, 2014b).18 Supporting public infrastructure should also contribute to reduce high logistics costs (given Russia’s extension) and contribute to regional income convergence. 19

Figure 5.
Figure 5.

Global Competitive Index Pillars

(Absolute levels; 1-7(best); distribution in 2006 and 2015)

Citation: IMF Staff Country Reports 2016, 230; 10.5089/9781498362856.002.A001

Source: Global Competitive Index (GCI) Database and IMF staff calculations

24. Russia’s experience with structural reforms suggests that the right diagnostics and the implementation of policy actions have been at times insufficient for progress. In this regard, the establishment of clear (measureable) targets, carefully sequenced actions, with appropriate accountability for their implementation, and frequent monitoring could help advance reforms, and in parallel, contribute to improve investors’ perceptions.20

E. Summary and Conclusions

25. The authorities have correctly identified in the past the needed structural economic problems affecting Russia. However the sequencing and prioritization of policy actions have not been sufficiently focused and appear to have been reactive to the changing economic environment. In particular, oil price changes and its volatility appear to be related with the strength of reform implementation. Insufficient progress in some key areas, as recognized by the authorities, constitutes one of the challenges to overcome, which is consistent with some evidence on mixed effectiveness of policy actions.

26. There is evidence of a gradual convergence of Russia’s performance to that of more advanced economies, though significant gaps remain. Progress in Russia’s GCI indicators in the past 10 years has been generally stronger for those indicators in which Russia’s performance was comparatively weaker in 2006. However, Russia continues to compare unfavorably with respect to OECD averages on a wide range of indicators. Most notably, Russia’s relative strengths and weaknesses have remained persistently similar to those observed 10 years ago. This suggests that, despite progress, the pace of reform has been somewhat limited in some areas.

27. The authorities’ view that oil prices will be persistently low and a RER more aligned to fundamentals should serve as incentives to build a less oil-dependent growth model.

Adapting to the lower RER will require closing competitiveness gaps further in areas where Russia still lags OECD, including on institutions; market competitiveness; technological readiness; business sophistication; and, innovation. Better leveraging Russia’s current competitive advantage on macroeconomic conditions, labor market flexibility, and market size is also important. In particular, leveraging Russia’s large market size will require firms to recalibrate the trade-off between varieties and volumes, as well as further trade integration.

28. Fiscal consolidation against the backdrop of lower medium-term oil prices creates both risks and opportunities for reform implementation. Delinking government spending from fluctuations associated with the oil price super cycle should limit RER fluctuations and provide the right incentives for firms in the tradable sector and workers alike. However, public spending in education (both basic and advanced), health, and economic infrastructure should be preserved if Russia is not to lose international competiveness. Changes in the tax structure (if needed) should target consumption rather than investment, and avoid affecting incentives to work and invest. Pension reform should both contribute to support fiscal consolidation and labor supply.

29. Clear targets, carefully sequenced actions, appropriate accountability, and frequent monitoring could help advance reforms. Cutting the distance with the OECD will require carefully designed and sequenced policy actions, rather than actions that are reactive to the changing external environment. Initiatives to evaluate changes in regulations with respect to their ability to bring Russia closer to OECD standards should allow a fast resumption of accession talks while geopolitical tensions subside.21

References

  • Blinkin, M. (2015), “Presentation on Road Infrastructure Trends in Russia”, mimeo; Moscow.

  • Government of Russia (GoR, 2000-15), “Presidential Address to the National Assembly and the Duma”, Moscow.

  • Government of Russia (GoR, 2011), “Strategy 2020”, Moscow.

  • Kyobe, A. (2016), “Raising Productivity Growth in Russia”, 2016 Article IV Consultation with the Russian Federation, International Monetary Fund, Washington, D.C.

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  • IMF (2013), “Anchoring Growth: The Importance of Productivity-Enhancing Reforms in Emerging Market and Developing Economies”, IMF Discussion Note, Washington, D.C.

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  • IMF (2014a), “Structural Reforms and Macroeconomic Performance: Initial Considerations for the Fund”, Washington, D.C.

  • IMF (2014b), “Russian Federation: Fiscal Transparency Evaluation”, Washington D.C.

  • Medvedev, D. (2015), “A new reality: Russia and global challengesRussian Journal of Economics, Vol.1, Issue 2, pp. 109129.

  • World Economic Forum (WEF, 2006-15), “Global Competitive Index Database”, (several issues), Davos.

1

The authors of this paper are Gabriel Di Bella, Oksana Dynnikova, Nina Chebotareva and Tatiana Chernisheva.

2

These 12 pillars include Institutions (Pillar 1; with 21 indicators), Infrastructure (2; 9 indicators), Macroeconomic Environment (3; 5 indicators), Health and Basic Education (4; 10 indicators), Higher Education (5; 8 indicators), Goods Market Efficiency (6; 16 indicators), Labor Market Efficiency (7; 10 indicators), Financial Market Development (8; 8 indicators), Technological Readiness (9; 7 indicators), Market Size (10; 4 indicators), Business Sophistication (11; 9 indicators), and Innovation (12; 7 indicators). In turn, these pillars are grouped in three categories “Basic requirements (Pillars 1 – 4); “Efficiency enhancers” (Pillars 5 – 10); and Innovation (Pillars 11 – 12). The paper uses a sample including 117 countries and 114 indicators for the period 2006-15.

3

The Russian Constitution (article 84) mandates the President to annually inform Parliament about the situation of the country, and on the guidelines of the internal and foreign policy of the State. This document’s structure makes it suitable to identify the authorities’ diagnostics, challenges and plans (e.g., the addresses of 2004-05 are referred to as a unified program of action for the following decade). Other documents reviewed include “Strategy 2020” (GoR, 2011), “Go Russia!”, which describes objectives and policy actions to transform Russia into a modern economy (2009); as well as the Prime Minister’s (2015) views on challenges and needed reforms.

4

The table reflects the average number of policy actions per indicator per pillar, as described in the presidential addresses for the period 2000-15. The table does not intend to be an exhaustive catalogue of actions, but rather to provide a sense of priority areas. Effective actions are expected to positively affect GCI performance.

5

Reforms associated with improving the functioning of the Federation are difficult to classify within the GCI framework. However, in the early 2000s significant efforts were aimed at establishing a basic set of rules to guide the relationship between the federal government and the regions, including by eliminating inter-state barriers for the moving of factors; establishing clear rules for tax sharing; and delineating the powers between federal, regional, and local levels of authority, among other.

6

For instance, the 2003 Presidential Address states that “Russia owes its economic growth above all to the unprecedented improvement in foreign trade conditions”; and that, “We must not forget that this favorable situation cannot and will not last forever”. Similarly, the 2015 Presidential Address states, “Russia should be ready for a long period of low commodity prices and, likely, external restrictions”. Conversely, Russia’s economic development strategy through 2020 (“Strategy 2020”) envisages high long-term oil prices (US$93/barrel in 2016 and US$112/barrel in 2020; GoR, 2011).

7

Two-year changes are considered to smooth year-to-year volatility and focus on more persistent changes.

8

Successive GCI vintages incorporate new countries against which Russia compares, on average, favorably. Accordingly Russia’s percentiles for 2015 when including all countries are better than those used in the paper, which are calculated on the basis of an unchanged country sample.

9

The OECD’s council decision approving Russia’s request for accession was adopted in 2007, but the process was placed on hold in 2014. Accession talks were organized around the work of 22 committees in charge of analyzing Russia’s policies. Seven among them issued opinions (including on foreign direct investment, labor and social policies, competition, and tax policy, among other), which described Russian policies and needed changes to converge to OECD standards. Given that many of these opinions were issued before 2014, it is likely that when the accession process resumes, an update may be needed for some of them. OECD accession is an open process, with no deadlines. The commission on economic development and integration (established in 2009 and that deals with Russia’s participation in the WTO and on OECD accession, under the Deputy Prime Minister in charge of economic issues) should facilitate convergence to OECD standards, as one of its tasks is to ensure that new (or modified) regulations take into consideration OECD recommendations.

10

We split OECD countries according to their performance in GCI indicators in three tiers from best performers to weakest.

11

Russia’s performance in 2015 is slightly better than the weaker performers among OECD countries on institutions (Pillar 1); basic health and education (Pillar 4); higher education and training (Pillar 5); financial development (Pillar 8); and technological readiness (Pillar 9).

12

Inspections constrain (at times) economic activity and market access, and result in losses for businesses. Official statements recognize the burden imposed by unwarranted inspections and the need to streamline them.

13

The automobile industry provides a good example of changes needed in business sophistication (Pillar 11). Government regulations (of 2006 and 2010) reducing import duties for car components and subcomponents in exchange for localization resulted in a number of car terminals establishing in Russia to supply (almost exclusively) the domestic market. The RER depreciation increased the ratio between car prices to income per capita. Lowering this ratio to support demand requires increased localization throughout the value chain, and further taking advantage of scale economies, both through increased trade integration and a reconsideration of available varieties.

14

According to the Ministry of Foreign Affairs, there is interest from a number of countries, including South Korea, Singapore, Thailand, and MERCOSUR (among other) to start trade negotiations between with the EEU.

15

There is limited disclosure of revenue loss due to tax reliefs and tax subsidies (IMF, 2014b).

16

Labor supply growth will be constrained for years to come even if recent positive population trends continue; indeed, if such trend continues the case for preserving education and health expenditures would be stronger.

17

Figure 5 shows that on Institutions (Pillar 1), Business Sophistication (Pillar 11) and Innovation (Pillar 12), there is stronger differentiation between best performers and the rest (i.e., the 2015 distribution of performance is bimodal). On basic education and health (Pillar 4) there is less cross country differentiation. On infrastructure (Pillar 2), higher education and training (Pillar 5), market competitiveness (Pillar 6) and technological readiness (Pillar 9), there are improvements across the board (the distribution of performance moved to the right). In contrast, the distribution of macroeconomic performance (Pillar 3), labor market efficiency (Pillar 7), and financial development (Pillar 8) moved to the left.

18

The Federal Law on PPPs (224-FZ) was signed in mid-2015 and came into force in 2016.

19

Data on regional income per capita for the period 1998-2014 suggests limited regional convergence, with large urban centers (and neighboring regions), and resource-rich regions explaining most growth at the aggregate level. At the same time, about 50 percent of investment on road infrastructure in 2014 was in Moscow and its metropolitan area (Blinkin, 2015).

20

The authorities monitor, e.g., the implementation of the 2012 decrees and other initiatives. The participation of independent local experts (e.g., from Research Universities) in the assessment of policy implementation in key areas should support accountability.

21

For instance, in January 2016, the government established allocations for key ministries for training of government officials by OECD experts.

Annex I. Obstacles to Firm Growth in Russia

We use firm-level data to investigate factors that deter firm productivity in Russia. We answer the following questions: 1) What stylized facts describe firms by relative size and productivity and differences across sectors? 2) What explains low productivity looking to sector survey indicators of structural characteristics?

Productivity is measured as the log of ratio of firm’s turnover to the number of employees. Data is from ORBIS for the period 2009-2012 covering around 700,000 observations. The coverage in ORBIS for Russia is high, comprising 49.7 percent of employment (the share of total employment hired by firms in the sample to the aggregate level of non-financial sector employment). The sample excludes firms with less than 1 employee and also drops firms in the 1st and 99th percentiles.

Structural indicators from Business Environment and Enterprise Performance Survey data (BEEPS) measure what firms perceive are the biggest obstacles. These capture five aspects of the business environment that firms face: (a) infrastructure quality, (b) financial development, (c) governance, (d) labor market flexibility, and (e) labor quality. Survey data covers manufacturing and services sectors. Within manufacturing the following subsectors are included: chemicals, rubber, plastics, non-metallic products; food, beverages, tobacco; machinery, equipment, furniture, recycling; metals & metal products; textiles, wearing apparel, leather; wholesale & retail trade; and wood, cork, paper products). Services are further disaggregated into transport, post and telecommunications, other services and construction. To test the correlations between productivity and the structural obstacles that firms face we estimate a fixed effect model with time and industry dummies clustered on firms to control for non-independence between firms. Clustering on firms allows to control for the similarity of firms. The model takes the form:

prodist=β1Sst+βAZist+ωst+ηt+ɛist

Where productivity of firm i, in sectors, at time t is prodist Sst are structural characteristics across sectors; Zist are firm specific controls (indicator of firm size and the log of total assets) and ω are sector fixed effects and η are time fixed effects.

prodist=β2Sst*TRAD+β1Sst+βAZist+ωst+ηt+ɛist

These fixed effects absorb a significant amount of heterogeneity, but a causal interpretation of the structural indicator is still difficult. In an attempt to overcome this, we use a difference-in-difference strategy (Rajan and Zingales (1998)). The identifying assumption is that if structural constraints impede firm productivity, their impact must be stronger in the tradable sector. Indeed, the percentage of firms in manufacturing (the tradable sector) report structural constraints as being a bigger constraint than those in the services sector. Firms that are exporting and competing in the global market are likely to be more sensitive to domestic constraints that would impede their external competitiveness. We assume the tradable sector includes firms in: chemicals, rubber, plastics, non-metallic products; food, beverages, tobacco; machinery, equipment, furniture, recycling; metals & metal products; textiles, wearing apparel, leather; wholesale & retail trade; and wood, cork, paper products. The coefficient of interest is β2 which captures the extent to which structural constraints affect productivity more in the tradable sector.

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1

Prepared by Annette Kyobe, with contributions from Francois Painchaud.

2

Productivity growth is the ultimate driver of growth in the long run. Development accounting literature shows productivity differences determine differences in income levels across countries (Bosworth and Collins 2003; Hall and Jones 1999; Klenow and Rodríguez-Clare 1997). Growth will be sustained to the extent it is accompanied by productivity growth, as growth driven by factor accumulation tapers off as the returns to more capital and labor diminish in the context of the neo-classical growth model.

3

One explanation in the literature for a muted export response is global value chains (Ahmed et al 2015). Here exchange rate depreciations not only favorably alter the relative prices of exported goods, but also the cost of the intermediate imported goods which partially offset competitive gains.

4

The Theil index measures export diversification, Papageourgiou and Spatafora, (2012).

5

The estimated equation is ΔlogXit=𝛽1Δlog REERit−1+𝛽2ΔlogREERit−1×Sit−1+𝛽3Sit−1+𝛽AZit+𝜔i+𝜂t+𝜀it where is exports of country in period, is the structural reform of interest, is a set of control variables (trading partner growth and export goods inflation), and capture country and time fixed effects, respectively. We use the negative of CPI REER change, i.e. a depreciation has a positive sign. The effect of the structural indicators on the export elasticity is captured by the coefficient on the interaction term. The equation is estimated on manufactured and services exports using data averaged over three years. Regressors are lagged to control for endogeneity.

6

BTICS are Brazil, Turkey, India, China and South Africa. EM income peers are Brazil, Chile, China, Croatia, Czech Republic, Estonia, Hungary, India, Indonesia, Kazakhstan, Latvia, Lithuania, Mexico, Poland, Russia, Slovakia, Slovenia, South Africa.; EM commodity exporters are Algeria, Angola, Argentina, Azerbaijan, Brazil, Bahrain, Bolivia, Chile, Colombia, Costa Rica, Ecuador, Gabon, Guatemala, Indonesia, Iran, Kazakhstan, Kuwait, Libya, Malaysia, Oman, Paraguay, Peru, Qatar, Saudi Arabia, Syria, Turkmenistan, United Arab Emirates, Uruguay, Venezuela.

7

Russia requires around 1 percent of GDP or $13.2 billion per year in investment (EBRD, 2015-2016).

8

Capital investment increases productivity growth, in the context of new growth models (capital generates constant or increasing returns, in contrast to neoclassical models where capital generates diminishing returns). For example, R&D efforts by one firm can spill over and affect the stock of knowledge available to all firms, increasing productivity (Romer, 1986).

10

The coefficient of variation for regional unemployment is higher in Russia than in the US, denoting less labor mobility, but lower than in Europe.

11

See “Russia’s Regions: Income Volatility, Labor Mobility, and Fiscal Policy”, Kwon and Spilimbergo, IMF, 2005. See also “Inter-Regional Convergence in Russia”, Guriev, 2012.

13

See WEO chapter 2, IMF 2015 for a discussion of the impact of the commodity prices on macroeconomic variables including capital accumulation and TFP.

14

We drop firms with less than one employee, and firms in the 1st and 99th percentile of the productivity distribution following OECD 2014. We keep the sample of firms the same over the period of interest.

15

Methodology is based on Regional Economic Issues, Special Report, March 2015. Competitiveness is defined as the set of institutions, policies, and factors that determine the level of productivity of a country. 1–institutions, 2–infrastructure, 3–macroeconomic environment, 4–health and primary education, 5–higher education and training, 6–goods market efficiency, 7–labor market efficiency, 8–financial market development, 9–technological readiness, 10–market size, 11–business sophistication, and 12–innovation. Data is from the World Economic Forum’s Global Competitiveness Report.

16

Compared to 22 percent in China and Lao PDR, the only other comparators (cross country Enterprise Survey data is sparse).

Russian Federation: Selected Issues
Author: International Monetary Fund. European Dept.
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    Federal Budget

    (12-month moving sum, billions of U.S. dollars)

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    Russia’s Competitiveness

    (Abs. level diff., 2015 vs. 2006; above 45 degree line = better)

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    Convergence of Russia’s GCI Indicators

    (With respect OECD averages, 2006-15)

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    Competitiveness: Russia vis-à-vis OECD

    (Global Competitive Indicators, in percentiles; 1 = best)

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    Global Competitive Index Pillars

    (Absolute levels; 1-7(best); distribution in 2006 and 2015)