IMF Calls for Stronger Economic Policies in Russia

Sources:
Bloomberg: Putin Faces “Unpopular” Decisions to Overhaul Russia’s Oil-Reliant Economy
China Radio Int’l: IMF Lowers Russian Growth Forecast on Global Headwinds
IMF: Russia Should Leverage Commodity Boom to Boost Growth
WB: Growing Risks: Russian Economic Report #26

Last week, the International Monetary Fund (IMF) lowered its prediction for Russia’s annual economic growth by half a percent, to 4.3% for 2011, and by .4%, to 4.1% for 2012. The IMF justified the downward revision based on two primary factors: (1) the recent slowdown in Russia’s economy caused by lower oil prices, and (2) a general slowdown of global growth. Before the global financial crisis, the Russian economy was growing by more than 7% per year. However, during the global crisis, Russia’s economic growth slowed dramatically and has not fully recovered since. Following the crisis, the country started exporting oil from its Oil Reserve Fund (oil the country stores for emergencies) as a way to increase oil revenue; however, the fund has almost been exhausted. This excessive reliance on oil revenue is dangerous as it makes the economy particularly vulnerable to sudden drops in oil prices. If the price of oil were to fall to the same level seen during the financial crisis ($40 per barrel), Russia would have a deficit of 8% of GDP.

According to the IMF report, there are four main policy areas that the Russian government should focus on to put the country’s economic growth back on track: monetary policy, fiscal policy, structural reforms to improve the investment climate, and banking sector supervision. In terms of monetary policy, the IMF suggests the Russian Central Bank concentrate on lowering inflation. Russia currently has an inflation rate of about 8%, which is down from 11.7% in 2009, but still remains very high compared to other emerging market and developed countries. The Central Bank can increase interest rates to increase the cost of borrowing, while at the same time making it more attractive for consumers to save money. Lower borrowing and higher saving will reduce the amount of money people will spend—in other words, demand will fall. At the same time, production of goods (supply) should remain constant, which allows prices to fall based on basic supply and demand principles.

The IMF recommends that Russia strengthen its fiscal policy by aiming for a “non-oil” fiscal balance (where spending equals total revenue minus oil revenue) instead of an “overall” balance (where total spending equals total revenue). Oil revenue is inconsistent as it rises and falls with the market price of oil. When the oil price is high, Russia has plenty of extra money to spend, however, that money can disappear overnight if the price of oil falls. Since Russia currently plans for high oil revenue in its budget, it would have to borrow money to meet its budgetary needs if the price of oil were to fall. By focusing on the “non-oil” fiscal balance, the Russian government will be able to keep its budget stable (the rest of the country’s revenue is less dependent on market forces) and avoid needless borrowing.

The third area in need of policy focus is Russia’s poor investment climate. In a recent survey of the BRICs (Brazil, Russia, India, and China, four major emerging market countries) and other emerging European countries, Russia ranked last in terms of government effectiveness, regulatory quality, rule of law, and control of corruption—all of which make doing business in Russia more expensive. Investors are reluctant to devote substantial amounts of capital to countries that have these added, unnecessary costs. In response, the government has announced a plan to tackle corruption, reduce state interference in the economy, and improve services for businesses to help attract investors.

Finally, Russia needs to strengthen its banking system to help protect it from economic shocks. The IMF’s assessment of Russia’s financial sector found that the quality of bank loans may be overestimated and that banks’ capital (cash) reserves are lower than they should be. Bad loans and low capital reserves are problems because if a high number of borrowers begin to default on their loans, the banks will lose a substantial amount of their income (interest and principal paid on the loans). The banks would then have to reduce their capital by the amount of their losses. If banks with low capital reserves experience large-scale defaults, they might become insolvent—they would “fail.”

The IMF recommended that the Central Bank increase its supervisory authority and the government adopt legislation aimed at consolidating supervision over the country’s banking system. In some regulatory systems, different regulators are responsible for overseeing different parts of banks. Since a parent bank is often responsible for covering the losses of its individual parts, large losses at one branch or subsidiary bank could threaten the entire banking company if the parent bank does not have the money to cover those losses. Consolidated supervision allows for one regulator to oversee all of a bank’s activities, which gives the regulators a better picture of how the bank’s business is doing as a whole. It also forces the parent bank to monitor the risk exposure and capital adequacy of its entire operation, which theoretically makes the entire bank more stable. Russia should be able to improve economic growth and stability if it can successfully address the IMF’s concerns, but making so many changes so quickly will not be easy.