The following OECD assessment and recommendations summarise Chapter 2 of the Economic survey of the Russian Federation 2006, published on 27 November 2006.
See also the excerpt "Fiscal Policy: The Principal Tool for Macroeconomic Management".
The adjustment to permanently high oil prices presents new challenges for economic policy
Russia needs to devise a macroeconomic strategy for a world of sustained high oil prices. Macroeconomic – particularly fiscal – policy has remained prudent. Despite some slippage in 2005–06, the authorities have largely resisted the temptation to use commodity windfalls to finance a spending spree. However, the events of the last two years have necessitated a reconsideration of the basic assumptions underlying policy. From the first recovery of oil prices in 1999 until the end of 2004, Russia’s broadly successful macroeconomic strategy rested on the assumption that high oil prices were a temporary phenomenon. This may yet prove to be the case, but expectations have shifted. It is important to recognise that the adjustment to sustained high oil prices creates problems of its own, with respect to both monetary and fiscal policy. The first is the loss of competitiveness that arises from rapid real exchange-rate appreciation. The second is the inflationary pressure that Russia’s ballooning external surpluses generate, given the authorities’ determination to limit the pace of nominal exchange-rate appreciation. Success in addressing these issues will depend above all on the efficient and prudent management of rapidly accumulating commodity windfalls. This must be seen as the principal macroeconomic policy challenge facing Russia today.
Real wages have recently been rising faster than productivity
Note: In 2005, real wages are not adjusted for the cut in the Unified Social Tax and thus overstate the increase in labour costs.
Source: Federal Service for State Statistics, OECD calculations.
The speed of real exchange-rate appreciation has prompted concerns about competitiveness
Over the long term, real appreciation in a catching-up economy is both inevitable and desirable. However, the pace of appreciation may cause problems, particularly if it is driven by abrupt terms-of-trade shifts rather than relative productivity dynamics. While labour market adjustment has so far allowed a smooth reallocation of labour from industry to services in Russia and thus limited the risk of “Dutch disease”, overly rapid real appreciation will significantly impede efforts to diversify its production and export structure. At the same time, efforts to limit the rate of nominal rouble appreciation make it harder to reduce inflation. The Bank of Russia has struggled to pursue these two goals simultaneously. So far, inflation has continued on a gradual downward trajectory, but it remains stubbornly persistent. Keeping the nominal effective exchange rate roughly stable has meant that real appreciation has come about mainly via high – and only slowly declining – inflation.
Real appreciation has come about chiefly via higher inflation
Decomposition aof real exchange rate appreciation, percentage change
Source: IMF, International FInancial Statistics.
Fiscal policy is the best tool for managing this adjustment…
The authorities aim to reduce inflation to around 4.5–5.0% per annum by the end of the decade. In present circumstances, however, the Bank of Russia’s policy options are limited, given the weakness of both the interest-rate channel and exchange-rate pass-through. A relatively tight fiscal stance, on the other hand, can reduce both inflation and exchange-rate pressures, thereby mitigating the competitiveness–inflation trade-off facing the Bank. Moreover, fiscal policy could play a critical role in sustaining not only budgetary expenditure but also growth and exchange-rate stability in the event of a negative terms-of-trade shock. Over time, financial deepening should allow the Bank to pursue a more effective anti-inflation strategy, relying on a wider range of policy instruments than at present, but fiscal policy remains the best instrument for managing the adjustment to the new terms of trade while achieving substantially lower inflation.
…and it should aim to insulate the economy from terms-of-trade volatility
Policy should be based on a clear, credible fiscal rule, aimed at insulating the economy from commodity-price volatility. In particular, it is critical that the budget capture a larger share of commodity windfalls than at present, so as to avoid boom-and-bust cycles, but the resulting fluctuations in fiscal revenues should not lead to pro-cyclical fluctuations in expenditure. Such a rule should thus define a medium-term fiscal balance target, based on an assessment of the non-oil fiscal stance and long-run sustainability. This basic fiscal rule could be operationalised via certain changes in the legislative framework governing the Stabilisation Fund:
The revenue base of the Fund could be broadened to include all oil-price related revenue windfalls (including surplus revenues from natural gas exports). A clearer set of rules is needed to govern the division of oil-related revenues between the Fund and the current budget.
The first RUB 500bn in the Stabilisation Fund can only be spent if oil prices fall below the threshold price of $ 27/bbl for Urals crude. This sum is actually rather small compared to the potential revenue losses that might arise in the event of such a sustained oil-price drop. It would therefore be prudent to increase the minimum size of this reserve and to index it either to GDP or to budgetary spending.
Nevertheless, the size of the Fund is, or soon will be, larger than is needed to insure the budget against an oil-price drop. The government should therefore design a framework for investing excess Stabilisation Fund reserves in a wider range of income-generating assets than is permitted for those funds that are set aside for “fiscal insurance”.
This de facto division of the Fund into its “insurance” and “income-generating” components points to the need for clearer criteria for determining when and how the Fund’s reserves may be spent. These criteria should reflect the requirements of the basic fiscal rule, since it is the underlying rule that matters most, not the specific mechanisms for operationalising it.
A large share of foreign exchange inflows has been sterilised by the Stabilisation Fund
Growth of net foreign assets and of the Stabilisation Fund, RUB billion
Source: Central Bank of Russia, Institute for the Economy in Transition.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of the Russian Federation 2006 is available from:
For further information please contact the Russia Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by William Tompson and Christian Gianella under the supervision of Andreas Wörgötter.
Assessing Russia's non-fuel trade elasticities: Does the Russian economy react "normally" to exchange rate movements?