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Russia has enjoyed five years of robust economic growth since the 1998 financial crisis. Nevertheless, concerns remain about Russia’s capacity to sustain high growth over the longer term, especially in view of its heavy dependence on export-oriented resource industries, particularly oil. There are dangers associated with such resource-dependent development, including vulnerability to external shocks, the risk of ‘Dutch disease’ and the institutional pathologies often associated with heavy reliance on natural resource sectors. The major challenge for Russia over the coming years will therefore be twofold. First, given that growth prospects will continue to depend heavily on resource sectors, the authorities will need to pursue policies that allow the further development of these sectors while acting to mitigate the risks associated with resource-dependent growth. Secondly, in order to facilitate the diversification of the Russian economy over the longer term, and thus to reduce its dependence on resource extraction industries, the authorities will need to pursue a range of structural reforms designed to create an environment conducive to investment in non-resource sectors.
Continued fiscal prudence must be the main priority for macroeconomic policy
Given Russia’s resource dependence and consequent vulnerability to external shocks, prudent fiscal policies are of the utmost importance. While good fiscal policy cannot eliminate external vulnerability altogether, it can do much to mitigate it. In particular, balancing the budget across the oil-price cycle is crucial. The new fiscal stabilisation fund is therefore to be welcomed, as it should help the authorities to achieve this goal while avoiding large fluctuations in government expenditure. At the same time, Russia’s external vulnerability could be further reduced by making sure that foreign currency denominated debt - both private and state debt - remains fairly low relative to GDP, and by facilitating further progress in ‘de dollarising’ the domestic economy.
Monetary policy in recent years has been characterised by a fundamental tension between two conflicting goals: reducing inflation and limiting the rate of appreciation of the real effective exchange rate (REER). While the latter concern is understandable, further disinflation is likely to require a clearer focus on inflation reduction as the main objective of monetary policy. The authorities should therefore be prepared to allow for a somewhat faster rate of real and nominal appreciation of the rouble than in the recent past. That said, upward pressure on the exchange rate during times of high oil prices or large capital inflows could be partially offset without adding to inflationary pressures by enlarging the range of non-inflationary sterilisation instruments, such as enabling the central bank to issue its own bonds. The newly established fiscal stabilisation fund could also play an important role in reducing short-term fluctuations in the exchange rate, particularly in conjunction with increased taxation of windfall profits in resource-exporting sectors.
Structural reform progress will depend crucially on improving the quality of state institutions
The principal structural reform challenge will be to pursue policies and create institutions that help to reduce Russia's dependence on resource exports over the longer term. Fiscal policy will have a role to play here. Increasing the tax burden on resource sectors (not only the oil sector) while reducing it for the rest of the economy could help to foster greater diversification of economic activity while mitigating the effects of real exchange-rate appreciation on competitiveness. Financial sector reform can also play a role in facilitating the diversification of economic activity. Despite recent rapid growth in lending to the private sector, mechanisms for efficiently allocating investment resources across - and not merely within - economic sectors remain underdeveloped. Further reform of the banking sector, in particular, is thus a key priority. At the same time, there is a crucial need to improve framework conditions for business, particularly small and medium enterprises. Reducing the burdens imposed by heavy regulation and an often corrupt bureaucracy, in addition to strengthening the financial system, would help to create a more level playing field for businesses. However, this aim cannot be achieved without substantial improvements in the probity, efficiency and accountability of the courts, the bureaucracy and other state institutions.
A further set of challenges facing Russia concerns restructuring large, state-controlled monopolies in natural gas and electricity, while creating legal and regulatory frameworks for these sectors that combine robust competition with effective regulation. Reform of the gas sector, in particular, should aim to secure greater choice for consumers and fair access to the marketplace and especially the transport infrastructure for all producers. At the same time, gas and electricity reform should enhance efficiency, not least by reducing the possibilities for rent-seeking by the incumbent monopolists and by putting an end to the provision of implicit subsidies via prices below full cost-recovery levels. The fact that the electricity and gas sectors will require a fair degree of regulation even after they are reformed makes issues pertaining to the competence and integrity of state institutions particularly relevant and highlights the importance of state reform.
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