The international crisis dealt a severe blow to the Russian economy. The lower oil prices and reversal of international capital flows to emerging markets hit the country hard because the shocks struck just as the economy was on a steep upturn and Russia’s dependence on oil made it particularly vulnerable.
As a result, economic activity fell precipitously. Faced with this challenging turn of events, the government mounted an economic policy response that was swift and unprecedented in its scale and contents. The banking pressures were addressed through large-scale liquidity injections and a rescue of problem banks, while fiscal policy became expansionary. At first, the Central Bank allowed gradual exchange-rate depreciation into early 2009, drawing on its foreign reserves to moderate the pace. This allowed banks and corporations to bolster their foreign exchange positions and brought the ruble in line with the new fundamentals implied by lower oil prices.
Looking forward, the global economy suggests a slow recovery as it will be facing deleveraging, corporate restructuring and slow job growth. Similarly, Russia cannot expect a rapid return of high oil prices or large capital inflows. We should therefore foresee a fairly modest recovery in Russia combined with a weaker balance of payments than in recent years.
This sobering outlook has important implications for the country’s economic strategy. Clearly, the government’s response over the last year has helped preserve stability, which is a prerequisite for the resumption of growth. In fact, since mid-2009, there have been signs of economic stabilization. But large challenges remain. The central goal will be to turn the tentative signs of a rebound into lasting economic growth, while preserving the stabilization gains. In this regard, Russia faces delicate trade-offs, as well as room for improving the boost to economic growth, both in the short and longer term.
Consider first the short-term policy priorities. Ensuring a healthy banking system will be critical for the resumption of credit supply. This underscores the need for a proactive and comprehensive strategy so that banks have the capacity to lend once the economy recovers. Key elements of this strategy should include mandatory stress tests of major banks to obtain better assessments of their viability. These tests should, above all, reveal whether banks have adequate capital or have the ability to raise more capital if needed, either from private sources or from the envisaged bank recapitalization by public funds.
Turning to budget policy, the cautious fiscal policy of the past has left Russia with a low public debt level and sizable buffers, creating “fiscal space” for relaxation. But the size of the relaxation should not be so large as to undermine the quality of public spending. Moreover, the use of the Reserve Fund for budgetary financing is effectively the same as printing money for this purpose, and this could easily threaten the stability of the ruble. The good news is that with a better composition of the fiscal stimulus, Russia could achieve the same boost to domestic demand with lower fiscal deficits. To this end, the fiscal stimulus should enhance social safety nets and infrastructure projects. Also, the government should keep in mind longer-term fiscal policy objectives. Emphasizing self-reversing spending categories now would allow more flexibility in budget policies later. The more convincing the medium-term fiscal plans are, the stronger the fiscal boost will be today.
On the monetary policy side, the Central Bank is facing a balancing act. Inflation is coming down and may undershoot the target this year. But at the same time, the ruble remains vulnerable to swings in oil prices, banks are still liquid, and the fiscal expansion may renew pressures. On balance, however, the gradual relaxation of monetary policy envisaged by the Central Bank would seem appropriate. But there is clearly a need for careful implementation to avoid instability while keeping an eye on capital flows, the exchange rate and depositor confidence.
Looking beyond the crisis, there is broad consensus on the need for Russia to achieve economic diversification. This would help Russia realize its economic potential and also make the country less vulnerable to the vagaries of financial and commodity markets. Diversifying would not necessarily mean an increase in hi-tech industries but could equally well involve such sectors as light industry and tourism. To achieve real diversification, however, Russia will need significant investment.
The reform agenda is well-known. The most important priorities are a rollback of state control, easing of entry for new firms, reforms of the public sector, strengthening anti-corruption efforts and gaining accession to the World Trade Organization. While the commentary on Russia’s medium-term policies tend to focus on these structural reforms, we should not lose sight of the macroeconomic foundations for balanced economic growth.
Both medium-term government budget policy and monetary policy will play critical roles in how Russia recovers. As for medium-term budget policies, the central issue is how the country over time would best benefit from its natural resource wealth. One option would be to conservatively aim for a public spending level consistent with the income that the government will derive from petroleum over the long haul. Taking the 2009 budget as the starting point, this would require considerable restraint in government spending once the economy recovers, while at the same time underlining moving forward with deep and comprehensive public sector reforms. Other options toward fiscal viability entail large fiscal adjustments. Whichever option is pursued, conservative fiscal policies will preserve Russia’s competitiveness and limit “Dutch disease” by avoiding excessive reliance on natural resources.
The second important condition for achieving sustained growth is to anchor inflation at a low and stable level. This can be achieved through higher domestic saving and investment. To this end, formal inflation targeting must become a goal of the government. The Central Bank has been making progress on the technical preparations for formal inflation targeting. Encouraging recent examples include increased exchange-rate flexibility and more public statements explaining interest rate decisions.
Russia must now concentrate its efforts on how to foster sustained growth. For the near term, the government’s strategy on the banking and budget sides should aim to facilitate an early recovery and protect stability. Russia has vast economic potential, and unleashing it will require a deliberate and broad economic strategy that encompasses sound macroeconomic policies and structural reforms.
Odd Per Brekk is senior resident representative at the International Monetary Fund in Moscow.