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The following OECD assessment and recommendations summarise chapter 1 of the Economic Survey of Russia published on 15 July 2009.
Between the financial crisis which struck Russia in August 1998 and the global crisis which broke out in earnest in September 2008, Russia had the strongest decade of growth in its history, with real GDP nearly doubling. This strong increase in output, coupled with the vigorous real appreciation of the rouble, driven mainly by the surge in energy and raw material prices, meant that nominal GDP measured in US dollars rose almost 7-fold during that period, more than in any other major country. A wide range of other economic and social indicators also saw dramatic improvements during those ten years. Total factor productivity grew strongly, real wages soared, and unemployment and poverty rates fell sharply. Strong current account surpluses, combined with a swing in the private capital account from large net outflows to even larger net inflows, pushed international reserves to nearly USD 600 billion, behind only China and Japan. The transformation of the government finances was particularly marked. After defaulting on part of its debt in 1998, the federal government ran a string of surpluses and almost extinguished public debt while building up foreign assets amounting to 13% of GDP by end-2008. The picture for inflation was more mixed, but for most of the past decade inflation was on a trend decline, falling from 85% in late-1998 to single digits by mid-2007. At that time, a combination of surging international food and energy prices and very rapid money supply growth in Russia pushed inflation back up to 15%, before it began to fall again in late-2008 as energy and commodity prices collapsed and money supply growth came to a sudden halt.
Real GDP growth was strong for a decade
Source: OECD calculations based on Federal Service for State Statistics.
While stronger macroeconomic policies and structural reforms both contributed importantly to the good economic performance through mid-2008, a good deal of the impetus to growth came from transitory factors, as was outlined in the 2006 Economic Survey of Russia. Initially, there was the 50% real depreciation of the rouble at the time of the 1998 crisis, which sparked a recovery driven by import substitution and facilitated by substantial underutilisation of capital, allowing rapid growth to occur without high rates of investment. Then, both during 1999-2000 and to an even greater extent from 2003 to mid-2008, the terms of trade improved sharply, driven mainly by a rising oil price. The loosening of conditions in international capital markets, with declining spreads for emerging market borrowers and rising net inflows combined with low interest rates in advanced countries, gave a further impulse to the strong increase in domestic demand in Russia.
The contribution of transitory factors to growth in recent years increasingly raised questions about the sustainability of the expansion, particularly as some of the favourable factors (such as oil prices and the compression of borrowing spreads for emerging markets) exceeded or approached record levels. Although investment grew robustly, it remained low in relation to GDP compared with other rapidly catching-up economies, and the economy began to show signs of overheating as capacity utilisation rates rose and labour shortages emerged. Real GDP growth was increasingly driven by booming domestic demand, while the balance of payments and the government budget both became increasingly reliant on oil, with non-oil current account and fiscal deficits rising steadily. There is wide agreement, including within the government, that a shift to a new more self-sustaining growth model is needed. The government’s Russia 2020 growth strategy, which aims for innovation-driven growth and reduced reliance on the production of raw materials, was developed in 2008 while oil prices were still high and rising, but the crisis struck before that strategy could even begin to be translated into concrete policy actions. It is therefore important to return to the structural reform agenda both within the context of anti-crisis measures and beyond.
Why did the global crisis hit Russia so hard?
The continuation of rapid growth had certainly become increasingly vulnerable to a decline in oil and gas prices, but a normal oil price downturn would probably have been consistent with merely a growth slowdown rather than the severe recession which is now under way. The size and speed of the decline in oil prices that began in July 2008 were greater than any previous episode, and the effects were exacerbated by similarly extreme falls in the prices of other export commodities. Financial turmoil, including the disruption of emerging market access to international capital markets, was also exceptionally severe. At the same time, world demand collapsed in the last quarter of 2008, dramatically shrinking world trade, which hit the volume as well as the price of Russian exports of metals and natural gas. The impact of these external shocks on the Russian economy was aggravated by domestic vulnerabilities, including fragile confidence in domestic banks and the currency.
The impact of the crisis was sudden and large
1. Estimated on the basis of data on change of physical volume of production in agriculture, mining and quarrying, manufacturing, electricity, gas and water supply, construction, transportation, wholesale and retail trade.
Source: Federal Service for State Statistics, Institute for the Economy in Transition, Ministry of Economic Development and VTB Europe.
The strategy for Russia in tackling such a big economic crisis needs to be broad-based, including a range of fiscal and monetary policy measures to support aggregate demand and maintain the functioning of the banking system. As in other countries, policymakers in Russia should seek measures that maximise the immediate demand effect; minimize distortions; protect macroeconomic stability and fiscal sustainability via a clear exit strategy from stimulus measures; and, where possible, yield longer-term efficiency gains while achieving short-term demand management goals. Designing a response that best conforms to these principles, including finding the right balance where there are trade-offs between them, is the overarching near-term policy challenge.
What has been the policy reaction to date, and how should it evolve?
The authorities’ reaction to the onset of the crisis was broadly in line with that of many OECD economies, although the response in Russia was unusually rapid and large, reflecting in part the substantial resources available to the authorities after years of fiscal and balance of payments surpluses. Liquidity and capital were provided to the banking system, deposit insurance limits were increased, and a number of expansionary fiscal measures were announced. All told, quantifiable announcements in the first months of the crisis were equivalent to about 13% of GDP. These measures were initially thought to be more than adequate to address the consequences for Russia of the global financial crisis, but it has become increasingly clear that Russia is facing a deeper and longer downturn than was imagined a few months ago. As the stock of available resources has dwindled while the cost of some initial measures has risen (notably the combination of limiting depreciation of the rouble while providing ample liquidity to banks) new measures are being more carefully weighed, especially with respect to possible risks to fiscal sustainability.
Demand-support measures will be less effective to the extent that the financial system is not operating smoothly. This implies that maintaining the functioning of the banking system is of prime importance. While liquidity shortages did trigger turmoil at the onset of the global crisis, the main threat to credit growth now appears to be solvency problems, arising from the declining capacity of borrowers to repay bank loans. Banks risk breaching regulatory capital requirements if, as expected, the downturn brings an upsurge in non-performing loans. Such capital shortages can force deleveraging as banks shrink their balance sheets to meet capital adequacy requirements. Banks may also be unwilling to lend as credit risks on new lending rise in an environment of negative real GDP growth both domestically and abroad. The challenge is to maintain capital adequacy and prevent a sharp curtailing of lending flows financing new activities, while minimising moral hazard and the cost to taxpayers.
Just as monetary conditions during the period of strengthening oil prices were too easy, as balance of payments strength fed through to money supply growth via the central bank’s exchange rate-oriented monetary policy, so they risk becoming too tight in a context of falling oil prices and capital outflows. Intervention to support the rouble in the months following the onset of the crisis meant sharply falling reserves, and this was accompanied by a large fall in M2 since September 2008. Real interest rates are becoming positive for the first time in years just as aggregate demand is collapsing due to adverse external shocks. In addition, the resistance to depreciation delayed a compensatory stimulus for non-oil tradable when the oil price fell. The stepwise widening of the exchange rate band allowed some breathing space for firms with heavy foreign currency liabilities and possibly prevented a sharper weakening of confidence in the rouble and, thus, a run on deposits. But the costs were heavy, as expectations of further depreciation encouraged capital flight. The central bank’s communication policy should foster the recognition that the real exchange rate eventually has to move in line with large swings in fundamentals such as oil prices. This episode revealed the weakness in the monetary policy framework and illustrated that holding to a fixed exchange rate or managing a float for an extended period is difficult, as serious conflicts with fundamentals are likely to arise sooner or later, particularly in a commodity-dependent economy.
The main short-term challenge for fiscal policy is to maximise the fiscal multiplier while managing moral hazard and risks to long-term fiscal sustainability. The former tends to suggest expenditure measures, possibly in the form of transfers to low-income households or lower levels of government, rather than general tax cuts. Temporary measures, such as one-off transfers or temporary tax rebates, can be one effective way of maximising the short-term demand impact. Measures that are hard to reverse, such as raising entitlements or cutting tax rates, could undermine long-term sustainability. The current crisis is increasingly looking like a more extended downturn than originally foreseen, which may make infrastructure spending more attractive than otherwise, particularly since there is evidence that the fiscal multiplier is highest for such spending. The threat to fiscal sustainability would appear to be less of a problem in Russia than in many OECD countries, given low levels of gross public debt and substantial public financial assets. Nonetheless, the federal deficit will be very large in 2009, and is likely to remain at high levels for several years. Moreover, Russia faces underlying negative demographic trends and particularly serious environmental degradation problems, which could entail major fiscal costs in the future. As in other countries, therefore, it will be important for Russia to set its stimulus efforts in a medium-term context that credibly charts a return to a sustainable public debt path.
Looking beyond the crisis, how can a better growth model be put in place?
At some point the crisis will end, and oil prices will probably recover sooner rather than later. In the medium term, Russia will face the challenge of putting in place a healthier model for sustained catch-up growth. This should be one based on innovation, investment, the accumulation of human capital and coherent implementation of the rule of law within a well regulated and competition-enhancing market economy, rather than one largely driven by strong but temporary improvements in the terms of trade and the increasing reliance on state corporations with inadequate governance structures as well as ad hoc support of selected banks and corporations. To this end, there is considerable scope for major progress in a wide range of areas. For example, education performance is mediocre; the healthcare system is deficient in a number of respects; innovation policy does not get the most from Russia’s considerable potential; administrative reform is needed to improve the efficiency of the public service; and some important prices, notably for natural gas, remain distorted, making the economy more energy-intensive than it should be. Many of these topics have been addressed in past Economic Surveys, and remain valid. Particular challenges discussed in this Survey include macroeconomic management, including the priorities for monetary and fiscal policy, the development of the banking system, and product market regulation reforms to widen the scope for competition.
How to obtain this publication
The complete edition of the Economic Survey of Russia is available from:
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.
For further information please contact the Russia Desk at the OECD Economics Department at firstname.lastname@example.org.
The OECD Secretariat's report was prepared by Geoff Barnard, Roland Beck, Paul Conway and Tatiana Lysenko under the supervision of Andreas Wörgötter. Research assistance was provided by Corinne Chanteloup.