IMF Concludes Article IV Consultation With Russia

by Ulrika Lomas, Tax-News.com, Brussels

13 August 2009

On August 7, the Executive Board of the International Monetary Fund (IMF) released details of its Article IV consultation with Russia.

In the wake of the global financial crisis, the Russian economy has been hit hard by dual shocks – a collapse in oil prices and a sudden reversal of capital flows. Fixed investment plummeted, significantly weakening the nexus of high growth in investment, productivity, and real wages that had powered consumption and the economic boom prior to the crisis. Against this background, real GDP contracted sharply in the first quarter, while labor market conditions eased considerably, dampening growth in real wages. As the output gap widens, inflation pressures are easing. Following an initial sharp depreciation, a recent modest increase in oil prices and renewed capital inflows have provided some support to the Ruble, which remains broadly in equilibrium, notes the IMF.

In April 2009, as the economy continued to contract, the government passed a large supplementary budget to support flagging domestic demand. The budget includes large discretionary increases in defense and security spending; along with a package of anti-crisis measures aimed at stimulating economic activity by reducing taxes, extending support to strategic sectors, and enhancing social assistance. As a result, the IMF expects that the non-oil deficit of the general government will widen by 5.5% of GDP in 2009 – reaching 13.75% of GDP. The deficit will be monetized by drawing down the Oil Reserve Fund, except for domestic borrowing of up to 1% of GDP.

Despite the substantial fiscal stimulus, the IMF believes that recovery will be slow in coming with important downside risks weighing on economic outlook. Going forward, the external environment is likely to remain challenging, as the subdued outlook for global growth implies only a gradual recovery in commodity prices, it further notes.

Against this backdrop, the IMF anticipates that real GDP will contract by 6.5% in 2009, after expanding at an annual rate of 7-8% before the crisis. The economy is projected to recover only slowly over the course of 2010, with inflation gradually falling. The IMF believes that the current account surplus will decline in 2009 before improving modestly in 2010, reflecting a gradual recovery of oil prices. Taking into account the planned large-scale monetization of the fiscal deficit, capital outflows are expected to remain relatively high at USD68bn.

In its recommendations, the IMF’s Executive Board noted that Russia’s pre-crisis policies have had important implications for the scope and effectiveness of the authorities’ response to the adverse external environment. On the one hand the IMF observed that Russia’s prudent policy of taxing and saving its oil wealth during the good years created room for a large fiscal stimulus. On the other hand, it noted that the pre-crisis policy of controlled ruble appreciation – combined with the lack of long-term domestic funding – contributed to excessive foreign currency borrowing as high oil prices helped inflate investor appetite for Russian assets, and left Russian banks and corporates vulnerable to a reversal of inflows.

On fiscal policy, most Directors questioned the size and reversibility of the stimulus currently underway. The Executive Board expressed concern that the large stimulus may become entrenched, leading to a renewed bout of excessive real appreciation and lower competitiveness, once the economy recovers. The IMF recommended scaling back the fiscal stimulus and reorienting its composition toward measures that are self-reversing.

The IMF welcomed the authorities’ intention to reinvigorate structural reforms in the health and education sectors. Concluding, the IMF warned against delays in implementing other reforms critical to improving Russia’s investment climate and promoting economic diversification.

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