Russia Urged to Reform Public Sector

by Tatiana Smolenskaya, Tax-News.com, Moscow

05 July 2010

The dramatic rise in Russia's permanent spending means that withdrawing the economic stimulus program would not be possible without reinvigorating long-delayed public sector reforms, according to the International Monetary Fund (IMF).

The IMF stated in its Article IV review that there was no firm strategy yet for withdrawing the huge fiscal stimulus. The Russian government had expected to start doing so this year, and to gradually lower the non-oil deficit to 9.5% of GDP by 2012, from 13.75% of GDP in 2009. However, with the recent supplementary budget, the IMF noted a small further expansion in 2010, suggesting a 'revisiting' of the planned pace of consolidation over the medium term.

The IMF thought the withdrawal of stimulus should start now, gathering significant pace in 2011-12. With cyclical conditions set to gradually normalize, and with lower potential growth, the IMF would like to see a plan for fully reversing the large increase in the non-oil deficit in the coming years.

Given the scale of the needed reversal, the IMF believes that striking an appropriate balance between short-term cyclical considerations and medium-term consolidation requires the withdrawal of stimulus sooner than planned. The IMF regretted the expansion of the federal government’s non-oil balance implied by the 2010 supplementary budget and was worried about the prospect of another supplement later this year.

Moreover, the previously planned target of reducing the non-oil deficit to 9.5% of GDP by 2012 remained, in the IMF view, broadly consistent with the current outlook for economic activity. Further into the future, the IMF thought the target of a non-oil deficit of 4.7% of GDP implied by the government’s long-term fiscal framework should remain the fiscal anchor.

The IMF considered that the budget had become increasingly inflexible; of the 8.5% of GDP increase in the underlying non-oil deficit compared to its pre-crisis level, three-quarters reflected higher permanent measures, with some 4.5% accounted for by higher pensions alone.

As a result, non-statutory spending was now only 9% of GDP, equal to the size of the consolidation needed to achieve the government’s own long-term target for the non-oil deficit of 4.7% of GDP by 2015. Without deep public sector reforms, the IMF thought there was little prospect for achieving the needed consolidation.

Reinvigorating long-stalled public sector reforms was thus a matter of urgency, according to the IMF. Cross-country comparisons suggested that significant savings could be achieved in health and social protection without compromising the quality of service delivery.

Moreover, the IMF regarded the pension system as not financially viable without comprehensive reforms, including a gradual but major increase in the retirement age. While reforms in these areas have been on the agenda for several years, the IMF thought they still had insufficient political support, and progress remained slow. Advancing such reforms was becoming essential to economic stability over the medium term.

The IMF recommended that the fiscal framework be strengthened. Supplementary budgets had been adopted every year since the 1998 crisis; in some years there had been several such budgets. With the exception of the recent crisis, the IMF noted that changes implied by supplementary budgets had, since 2004, invariably run counter to what would have been required from a cyclical perspective.

According to the IMF, the recent shift in focus of fiscal policy to the overall balance, rather than the non-oil balance, had in effect increased the pro-cyclicality of fiscal policy. In this regard, the IMF regretted that the 2010 budget was, for the first time in many years, based on an oil-price assumption that was above the futures price.

To ensure an effective counter-cyclical fiscal stance, the IMF recommended strengthening the medium-term budget framework as a matter of priority, starting by eschewing the use of supplementary budgets and firmly focusing on the non-oil deficit.

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