Mission Concluding Statement 

Russian Federation: Staff Concluding Statement of the 2020 Article IV Mission

November 24, 2020

Washington, DC: An International Monetary Fund (IMF) mission, led by Mr. Jacques Miniane, conducted remotely the 2020 Article IV consultations with the authorities of the Russian Federation. At the end of discussion, the mission issued the following statement:

Bringing the COVID-19 pandemic under control and avoiding lasting damage to the economy is the foremost challenge facing policymakers. Fiscal and monetary policy credibility are key, and credibility in Russia has been hard-earned with years of strong policies. These policies have helped build macroeconomic policy space, which has rightly been tapped to combat the crisis. Russia should continue to do so, extending support for its people and firms until the recovery is properly entrenched. This will foster a quicker return to strong activity, thereby facilitating also a normalization of macroeconomic policies. While the focus on crisis priorities is understandable, policymakers will need to sustain efforts to address structural factors that constrain potential growth.

Outlook and risks

The economy was showing signs of a healthy recovery that is now under threat from a sharp rise in infections. The large contraction in the second quarter was not as severe as in most other G20 countries. Russia’s strong fiscal, monetary, and macroprudential response to the crisis helped put a floor under the downturn and fostered a stronger-than-projected rebound of third quarter gross domestic product (GDP). Some restrictions have now been reintroduced, but we expect these restrictions to have a less severe impact than those of the spring. All in all, we project the economy to contract by about 4 percent this year, and to expand by some 2½ percent in 2021, assuming the COVID-19 situation gradually normalizes. Nevertheless, the economy will remain well below full employment for the foreseeable future.

Downside risks dominate in this highly uncertain environment. Activity in the coming months could prove weaker if stronger lockdowns need to be imposed, in turn bringing about new layoffs and further stretching firms’ balance sheets. Furthermore, geopolitical tensions cloud the outlook. Over the medium term, however, recent positive news on vaccine effectiveness have lowered the risk of a prolonged crisis with no medical solution at hand.

Policy discussions

Fiscal policy

The Russian economy entered the crisis with a sound fiscal framework and substantial policy space. Fiscal consolidation following the 2014/15 crisis has resulted in very low levels of debt as well as in substantial savings in the National Wealth Fund. Moreover, the consolidation was done within the framework of a fiscal rule that has reduced uncertainty and helped delink the budget and the economy from volatile oil prices.

This policy space allowed the authorities to mount a forceful public health and economic response to the crisis. In our estimates, the fiscal measures amounted to about 3.5 percent of GDP, or some 4.5 percent if off-budget measures are also included. Income support measures in the form of expanded social and unemployment benefits bolstered household incomes at a time of need. In addition, our analysis shows that firm support measures buffered liquidity and solvency pressures to a significant degree, thereby limiting long-term scarring effects. It is also commendable that support was relatively well targeted, and that proper measures were put in place to limit fraud and abuse.

We welcome the recent extension of some of the support measures, and encourage the authorities to stand ready to do more. The extension of tax deferrals for firms in sectors which are affected anew by restrictions is a good step. However, were the economic situation to weaken again as projected, the authorities should consider extending the deferrals further, as well as ensuring that the conditions to convert subsidized loans into grants remain compatible with underlying economic developments. Broadening the set of sectors and firms that receive support could also come into play if more restrictive lockdowns are instituted or if stress reverberates more widely in the economy. Separately, the authorities should consider reinstating the higher unemployment benefits while the crisis persists and until there is a meaningful recovery in employment, as the pre-crisis benefits are very low relative to the cost of living.

Tax policy and the targeting of social spending are moving in the right direction. The permanent reduction in SME social security contributions is a positive move that could go a long way towards reducing high informality in the sector. The reduction of inefficient tax exemptions in the oil sector is also welcome, and staff encourages the authorities to continue identifying and eliminating inefficient exemptions in other sectors. Other tax policy measures planned for next year will also contribute towards a more equitable, progressive tax system. Regarding social assistance, staff welcomes the fact that new welfare programs are being means-tested and are thus better targeted; we fully support the government’s ongoing plans to better target the remaining welfare programs as well.

Monetary policy

The BoR has eased its monetary stance during the year . The BoR has cut the policy rate by 200bps to 4.25 percent, a record low, and introduced new tools to provide liquidity. Monetary policy transmission is working, with lending and deposit rates falling closely in line with the policy rate. Credit growth has also held up well, not least thanks to various credit-targeted policies. Inflation has accelerated in recent months reaching 4 percent in October, but this acceleration is likely temporary as it owes largely to the recent ruble depreciation.

We project below-target inflation for some time and hence recommend policy easing in the coming months. In our baseline, we project inflation at 3–3½ percent in the second half of next year. Consistent with this, while there remains considerable uncertainty about the assumptions underpinning the baseline, we see significant economic slack persisting under most assumptions. In addition, while we take note of the increase in household inflation expectations, we worry that market-based measures of expectations are below 4 percent. This argues in our view for policy easing in the coming months to keep inflation at target and preserve room to respond to future shocks. At the same time, we acknowledge that some risks outside the control of the central bank could trigger inflationary pressures if they materialize. But we view the materialization or not of these events as largely independent of BoR policy rate levels, and they could be addressed if and when they occur with a range of policy adjustments.

We support the BoR engaging in FX operations when market conditions are disorderly. Such operations help reduce excess volatility at times of stress. At the same time, the BoR should separate regular FX purchases/sales under the fiscal rule, which should remain on their monthly schedule for transparency purposes, from FX operations aimed at reducing disorderly market conditions.

Financial sector policy

Banks entered the crisis from a position of strength. The banking system had adequate capital (capital adequacy ratio of 12.7 percent) and liquidity. Profitability also reached peak level before the crisis. And while NPLs as a share of loans were high at above 9 percent, they were conservatively provisioned.

The BoR implemented measures to mitigate the effects of the pandemic on the banking sector. Regulatory forbearance on loan classification and provisioning incentivized loan restructurings for debtors under stress, with restructurings exceeding a notional value of six and a half trillion rubles. Forbearance on securities and FX asset valuations, as well as the elimination of macro-prudential risk-weight add-ons on mortgages and to some extent on unsecured loans granted before the crisis, were other measures adopted.

Banks losses so far appear manageable for the banking system as a whole, but this should be interpreted with caution. Based on the amount of loans restructured so far, loan losses are not expected to put much pressure on the capital of most banks, if at all. We also take note of central bank stress tests showing that capital buffers could withstand a significantly more severe scenario than what is currently projected. Nevertheless, while forbearance remains in place, supervisors should track the health of restructured loans closely, to accurately gauge the needed (instead of actual) provisions. In addition, the central bank should continue encouraging banks that can afford to fully provision to do so without delay. Once loan classification/forbearance expires, we advise that it not be renewed, as it obscures the true asset quality of banks. Should needed provisioning bring any bank’s capital ratio under the regulatory minimum, the current situation warrants granting solvent banks additional time to restore capital, conditional on a credible plan.

Structural policies

While the focus on crisis management is understandable, addressing low potential growth remains an important priority. Growth in the years preceding the crisis only averaged 1.5 percent, stalling Russia’s convergence to advanced economy income levels. In our view, medium-term potential growth stands at 1.6 percent, low for an economy of Russia’s per capita income levels. Previous Article IV consultations focused, inter alia, on the need to improve the business climate, increase competition within and across regions, and strengthen SOE governance. In this context, the recent regulatory guillotine is welcome, though it remains to be seen how effective it will be at eliminating the large maze of regulations many of which are a historical legacy. The focus of the structural discussions this year was on the large national projects.

The national projects present both an opportunity to bolster potential growth in the economy, as well as some risks. If done well, they could materially improve infrastructure, strengthen skills, and increase diversification and exports. But they should not be seen as a substitute for the important reforms mentioned above, nor should they contribute to expanding the already large footprint of the state on the economy. Instead, maximizing their impact will require a level playing field to ensure strong private sector participation.

The mission would like to thank the authorities and other counterparts for the candid and constructive dialog.