Mission Concluding Statement 

Russian Federation—Concluding Statement for the December 2013 Staff Visit

December 11, 2013

Growth has slowed further while inflation remains above target and vulnerabilities persist. Fiscal consolidation underpinned by pension reform, while preserving productive investment spending, is necessary to support stability, growth, and rebuild buffers. Monetary policy should remain on hold with a tightening bias to lower inflation. Greater exchange rate flexibility is serving as an effective external shock absorber. Structural reforms are needed to boost Russia’s growth potential.

1. Growth remains modest. GDP is expected to grow by 1.5 percent in 2013. A large contraction in investment, following the completion of large energy and other public sector projects in 2012, has been an important drag. Sustained credit growth and robust wage increases have supported consumption, to date. Growth is projected to pick up slightly to 2 percent in 2014, on the back of stronger exports and a recovery in investment.

2. Inflation remains above the target. Despite the significant slowdown in growth the economy seems close to full capacity. CPI inflation is expected to remain above 6 percent through the end of the year, mostly reflecting increases in food prices.

3. Vulnerabilities persist. Domestically, continued rapid unsecured credit growth poses increasing financial risks, especially in light of slowing growth. Externally, the prospective tightening of international financial conditions could create further pressure on the exchange rate. Moreover, the economy and public finances remain highly sensitive to oil prices. More generally, slow progress on structural reforms hampers business climate and confidence.

Fiscal policy

4. The federal government fiscal deficit is projected to be 0.8 percent of GDP in 2013. Non-oil revenues have been somewhat weak, due to low real economic growth and tax exemptions, while oil revenues have remained strong. However, overall weaker revenues and lower than budgeted privatization receipts mean that there will be no transfers to the Reserve Fund in 2013, despite oil prices having been higher than the budget benchmark.

5. The 2014–16 federal budget is consistent with the fiscal rule. However, it has some weaknesses. The 2014 budget appears achievable. The 2015-16 budgets will rely on several one-off elements and their realization more challenging. Revenues for those years appear optimistic, including due to high oil price assumptions. Revenues in 2016 include one-off privatization receipts. The Pillar II diversion in 2014 should be saved, to avoid pressures from its unwinding in 2015. Proposed off-budget loan guarantees and use of part of the National Wealth Fund for infrastructure financing would result in additional spending. As a consequence, overall expenditures will likely remain higher than that envisaged in the federal budget.

6. The fiscal rule helps contain spending pressures and smooth volatility, but is insufficient to rebuild fiscal buffers. Fiscal space to respond to shocks is still limited. The Reserve Fund, at about 4 percent of GDP, remains below the target of 7 percent of GDP and is, under current policies, expected to fall further. The authorities should gradually tighten fiscal policy to rebuild fiscal buffers. This should be backed by pension reform and expenditure rationalization, while protecting productive investment spending. The proposed property tax could help provide fiscal space for investment at the sub-federal level. All spending should be gradually brought on budget.

Monetary policy and financial sector

7. The Central Bank of Russia (CBR) should keep policy rates on hold with a tightening bias. Core inflation has recently stopped declining. Fiscal policy in 2013 was looser than desired, creating inflationary pressure. With the economy running close to full capacity, the CBR should be ready to take further steps if inflation projections remain above target.

8. The CBR should continue with steps towards greater exchange rate flexibility. Increased exchange rate flexibility is serving Russia well as a shock absorber. In this regard, a quicker move to broader exchange rate flexibility could be a useful tool to deal with a prospective tightening of international monetary conditions.

9. Rapid unsecured consumer credit growth remains a concern. Lending in this category has slowed, but is still high at around 30 percent y-o-y. Unsecured consumer lending now accounts for around half of total retail lending. The authorities have taken several prudential measures, including tightening risk weights and raising provisioning, to slow unsecured credit growth. The authorities should consider further measures if lending in this category does not slow down further.

10. Bank supervision is strengthening. The CBR has expanded supervisory powers under the new mega-regulator law. In recent months the CBR has closed around 25 banks, signaling a strong commitment to deal promptly with weak banks and anti-money laundering-related issues.

11. Structural reforms are needed to boost Russia’s potential growth. Recent measures to improve the business environment and stimulate small- and medium-sized enterprises (SMEs) MEs proved insufficient to enhance growth potential. Inadequate infrastructure, constraints on access to finance for many firms, especially SMEs, and skill mismatches in the labor market appear as key obstacles. More decisive implementation of corporate governance reforms and of the lagging government privatization plans for SOEs and state-owned banks is needed to reduce the government footprint in the economy. Deeper global integration, notably through WTO entry, and steps towards OECD accession, present an opportunity to improve the efficiency of the economy. Collectively, such steps should help Russia retain domestic savings and attract foreign investment to support growth.