Russian Federation: IMF Staff Concluding Statement of the 2016 Article IV Mission
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision. The Russian economy continues to adjust to the dual shocks of lower oil prices and sanctions. The economic contraction is nonetheless shallower than previous recessions as the authorities’ economic package—a flexible exchange rate regime, banking sector capital and liquidity injection, limited fiscal stimulus, and regulatory forbearance—cushioned the shocks, helped restore confidence and stabilized the banking system.
Outlook and Risks
Yet the recession is extending into 2016, with the economy expected to contract by about 1? percent due to lower oil prices, weak household income growth, and fiscal consolidation. With oil prices expected to stabilize and domestic financial conditions to ease, the economy is projected to start growing again in 2017 by about 1 percent. Inflation has decelerated significantly due to weak economic activity, a tight monetary policy stance, and the government’s restrictive income policies. Inflation is expected to reach about 6? percent at end-2016 and fall further towards the central bank’s inflation target during 2017. However, medium-term prospects remain subdued due to a weak oil price outlook, adverse population dynamics coupled with long-standing structural bottlenecks, and the impact of sanctions on productivity and investment. Barring significant structural reforms, long-term growth is likely to settle around 1? percent.
A key downside risk to this outlook is lower-than-projected oil prices which would adversely affect growth, even if existing buffers would make the situation manageable from an external stability perspective. Also, the absence of credible measures to balance the budget in the medium-term could foster uncertainty and further limit growth. Finally, a persistently weak banking system could negatively weigh on economic prospects as constrained credit supply would affect investment.
Policies should focus on managing the necessary adjustment to lower oil prices while supporting the recovery by: (1) anchoring the required fiscal adjustment in a credible medium-term plan and balancing the adjustment to minimize the short-term impact on growth; (2) resuming monetary policy loosening as inflation risks subside to mitigate the expected fiscal consolidation and support the recovery; (3) strengthening financial sector institutions to better support growth; and (4) advancing structural reforms to leverage the more competitive exchange rate and rebalance growth towards non-energy tradable goods.
1. Fiscal Policy
The authorities have taken bold initial steps to lower the fiscal deficit. However, the required fiscal adjustment, estimated at about 4-5 percent of GDP over the medium-term to attain a balanced budget, remains significant. Moreover, a smoother fiscal adjustment plan based on quality and permanent measures, anchored within a credible multi-year framework would have been preferable. As such, reintroducing in the 2017 budget the three-year budgeting framework together with a credible fiscal rule is critical to help reduce policy uncertainty by providing greater clarity over future fiscal measures. In addition, any fiscal adjustment should safeguard growth-enhancing expenditures such as efficient public investment, education and health care spending. Finally, a parametric pension reform has become urgent to reap the necessary fiscal benefits in a timely manner. In addition, this reform should strive to develop and preserve sources of long-term financing.
2. Monetary Policy
Monetary policy has been appropriately on hold since August 2015. However, monetary policy normalization could resume as inflation is on a declining path and inflation expectations continue to fall. In addition, the improvement in the external position is limiting potential depreciation pressures that may fuel inflation. This said the pace of easing should be gradual given volatile oil prices, uncertainty about future government’s income policies and the behavior of wages. In addition, policy tightening in the United States or emerging market jitters could limit the central bank’s room to ease its policy stance.
3. Financial Sector Policies
The banking system has been kept stable by the authorities’ policy response, which included liquidity provision, capital support, and temporary regulatory forbearance. To make the banking system stronger and more resilient to downside risks, the authorities are encouraged to implement the main findings of the Financial Sector Assessment Program1 by (1) improving the resolution framework to minimize the use of public funds; (2) conducting a review of banks’ asset quality with a strategy to use its findings to strengthen banks’ capital; and (3) further improving supervision and regulation, among other things, regarding related party lending on an arm’s length basis, and stepping up supervisory interactions with external auditors. In addition, legislative amendments will be necessary to expand the range of macroprudential policy tools. Finally, over the medium and longer term, the diversification and deepening of the financial sector are priorities to support strong and sustainable economic growth. Policies should emphasize pursuing the closure of weak banks, encouraging the involvement of the private sector in bank resolution, and proceeding with privatization of state-owned banks as economic conditions permit.
4. Structural policies
Russia has the opportunity to diversify its economy as a result of a more competitive exchange rate. However, the macroeconomic recommendations above need to be supplemented with reforms to facilitate the reallocation of resources to the non-energy tradable sector. In this regard, trade integration initiatives to widen the scope of market access for exporters will be important. Finally, to deliver on the needed increase in investment, specific structural reform priorities lie in the following areas:
• Institutional improvements. Accelerating reforms to reduce unwarranted administrative pressures on businesses while improving the framework to settle disputes between the private and the public sector. Strengthening contract enforcement and the protection of property rights.
• Labor market policies. Increasing mobility and reducing skills mismatches by improving education quality and vocational training, increasing the coordination between employers and training institutes, and strengthening active labor market policies. Pension reform, especially increasing the statutory retirement age, could increase future labor supply.
• Investing in innovation and infrastructure. Supporting innovation for higher value added sectors and protecting infrastructure spending while directing it to bottlenecks in electricity and transport.
The IMF team expresses its appreciation for the authorities’ cooperation and candid discussions.
1 The views of the mission reflect the findings of the Financial Sector Assessment Program (FSAP), which was conducted by the IMF over the period February 2016-March 2016. Countries with financial sectors that are considered systemically important, such as Russia, must undertake a mandatory stability assessment every five years.