Published 25-03-2013, 10:30
What is the outlook for the Russian economy in 2013 and the medium term? The answer rests on two factors: what happens in the rest of the world and how successful the Russian government is in meeting the demand for deep structural reforms. According to the International Monetary Fund's World Economic Outlook (WEO) update published in January, global growth will accelerate slightly, from 3.2% in 2012 to 3.5% in 2013, and further to 4.1% in 2014. Compared with our forecast in last October's WEO, this means broadly unchanged growth for most large economies and regions. The exception is the euro area, where we have lowered the growth forecast for 2013 from plus 0.2% to minus 0.2%, in other words a continued contraction this year, and that will hurt Russia.
These are baseline projections and assume continued economic policy progress. Indeed, substantial progress has already been made with the European Stability Mechanism, key elements of a European banking union agreed on and the announcement of the Outright Monetary Transactions by the European Central Bank. The projections also assume that the US will come to grips with the remaining risks associated with the so-called "fiscal cliff" and the federal government debt ceiling. The possible lack of follow-through to deal with any of these problems remains a key risk going forward.
The main spillover from international problems for Russia’s economy is the effect they have on oil prices, but so far there has been little impact on our baseline projections for Russia. Oil price expectations were lowered a little in the latest WEO Update, but the current slowdown in Russia is mainly caused by domestic factors.
Russia was the G20 country hardest hit by the global crisis, with GDP contracting by almost 8% in 2009. Over the next two years Russia began to recover, driven mainly by private consumption, growing by about 4.5% a year. However, in 2012, the recovery stalled again, falling to about 3.5%. The currently low unemployment and high capacity utilization rates suggest that economic activity is now close to, if not above, its potential. We expect growth to remain at a moderate 3.8%.
The return of uncertainties for the global economic outlook means more uncertainty for Russia. At the same time, core inflation remains high and is expected to stay above the Central Bank of Russia's (CBR) forward-looking target path, aimed towards 4-5% inflation by end-2014.
Against this backdrop, the government has renewed its energies to promote economic growth. It has set an ambitious 5% increase in GDP target as a medium-term target. At the same time, IMF research suggests that Russia’s "growth model" of the last decade ― which produced a decent 5.0-5.5% average annual growth ― may have run its course.
In the past decade most of the growth came from increasing capacity utilization and improvements in the efficiency of existing production capital, rather than investment in new and productive capacity. Rising oil prices fuelled the process. But now we believe economy is pushing up against its capacity constraints.
Implications for Russia’s economic policies
The need to change model presents both several short- and long-term challenges. The first order on the agenda is to prevent domestic demand from expanding too fast and that way overheat the economy, while at the same time build more flexibility and "fiscal space" to respond to possible external shocks.
As there is little unused potential left, growth cannot be increased by simply stimulating domestic demand. Fiscal or monetary stimuli would boost prices and weaken the balance of payments. Instead, economic policies need to boost productive investment in new capacity; the Russian government needs to focus on the supply side of the economy.
The IMF is recommending that Russian policymakers aim for a more ambitious fiscal policy tightening in 2013 than the 0.5% of GDP envisaged in the current budget (measured by the non-oil deficit). Besides containing domestic demand, this approach would help build "fiscal space" to respond to any adverse spillovers from international developments.
Second, Russia needs to keep monetary policy on hold, but with a tightening bias. The CBR is in the midst of switching to an inflation-targeting regime. It is making laudable progress in putting together the underpinnings of this regime, notably a more flexible exchange rate. To build up its credibility as an inflation fighter, meeting the official inflation targets will be especially important in the short term.
Looking further down the road, Russia needs investment in new and productive capacity if it is to achieve faster growth, and so needs to become more investment friendly. Here there are three things Russia can do.
First is ensuring macroeconomic stability. Here, Russia is doing well and the new "fiscal rule", which bases budgetary spending of oil revenue on long-run oil prices, as well as the inflation-targeting policy is what is needed. These are the "policy anchors" needed for economic stability that Russia has been missing.
That said, the fiscal framework could also be further strengthened. While the new fiscal rule will help shield the budget from the volatility of oil prices, it is not enough to deal with the issue of large public sector liabilities over the longer term, especially the state's pension obligations.
As for monetary policy, Russia now has a more flexible ruble exchange rate and has scaled-back foreign exchange interventions, which has freed the CBR to fully focus on inflation. We strongly endorse the CBR's plans to further strengthen monetary policy instruments, money markets, communication and inflation projections, to be ready for the adoption of inflation targeting by the end of next year.
Second, Russia needs a more developed and stable financial sector. To bring Russia in line with international standards the CBR needs adequate authority to effectively supervise the bank sector and address the issue of related-party lending. It also needs enough power to act on the basis of its professional judgment when dealing with individual banks. In the short term, the IMF shares the CBR's concern about the rapid growth of unsecured retail credits, and supports the prudential measures the CBR says it will impose to tackle the danger that booming consumer lending can create.
Third, Russia needs an improved "investment climate," which will be critical to lifting Russia up to a higher growth trajectory. Russia’s recent move from 118th to 112th place in the World Bank’s "Doing Business" ranking is welcome progress, but the ranking also shows that there is still much to do.
Russia's accession to the World Trade Organization is also a net positive that will help improve the investment climate by making the rules clearer and more predictable. The government's renewed focus on privatization is also welcome in this context, and should be supplemented by efforts to strengthen property and minority shareholder rights, scale back unnecessary bureaucratic procedures, address corruption, and generally strengthen the rule of law.
Overall, our analysis suggests that if policy is based on these three pillars, the Russian economy could significantly improve on its current performance, growing by as much as 6% annually over the medium term. Which scenario will materialize will depend on the government’s economic policy choices.
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