EBRD:Russia country assessment

The Russian economy is beginning to be affected by the global economic slow-down through falling export demand and weaker investor and consumer confidence. Output grew by 4.3 per cent in both 2010 and 2011, aided by expansionary fiscal policies, high oil prices and associated services sector growth. However, as eurozone developments started to affect the Russian economy from the end of 2011, industrial production and retail sales growth slowed down, while agricultural output fell due to adverse weather conditions.  Net capital outflows have continued and reached US$ 57 billion during the first three quarters of 2012. The official unemployment rate declined to the pre-crisis level of around 5.5 per cent by mid-2012 but does not capture unofficial unemployment and differs widely between Russia's 83 regions. On current trends, GDP growth is expected to slow down to 3.2 per cent in 2012 and record a similar level in 2013.

The Central Bank of Russia (CBR) has started to put more emphasis on price stability as a priority and has already significantly increased exchange rate flexibility. In part as a result of, but also helped by, falling global food prices and delayed administered price increases, inflation declined to a record low of 3.6 per cent year on-year in April-May 2012, from 8.4 per cent in 2011. However, inflation has picked up since then to 6.6 per cent in September and is expected to be close to 7 per cent by the end of the year – well above the 5-6 per cent inflation target.  The CBR aims to keep its end-year inflation target at 5-6 per cent for 2013 and to reduce it to 4-5 per cent for 2014-15.  It plans to complete the transition to inflation targeting and a free floating rouble by 2015, which should help to improve the economy's resilience to shocks.

Russia’s outlook for growth remains highly dependent on commodity prices, particularly oil and gas. Other vulnerabilities stem from significant private external debt of around US$ 500 billion, or over 25 per cent of GDP, and the high sensitivity of the fiscal balance to the oil price. General government gross debt was around 12 per cent of GDP at the end of 2011. The non-oil deficit now exceeds 10 per cent and the budget-balancing oil price has increased to around US$ 115 per barrel. A sustained drop in the oil price would thus threaten fiscal sustainability and could lead to additional capital outflows, further pressure on the rouble and a credit freeze. In late June 2012 the government approved the use of an additional RB 200 billion from the Reserve Fund for real and financial sector support in case global market conditions deteriorate further. However, fiscal space is more limited now than during the 2008-9 crisis, when similar anti-crisis measures amounted to RB 1.2 trillion.

To improve fiscal sustainability, the authorities plan to limit government spending and make fiscal policy more countercyclical. In the autumn of 2012 a new fiscal rule was adopted, according to which future budgets will be based on the long-term average oil price rather than on the expected oil price during the budget year. However, implementation of this fiscal rule is likely to be delayed as it would only be gradually phased in, and the 2013 budget will still be based on a higher oil price than that implied by the new rule. Nevertheless, the draft medium-term budget framework aims to reduce spending growth and targets a balanced budget by 2015.

Highlights of the past year (2012)
•    The Russian economy has not been immune to the impact of the eurozone crisis. Both external and domestic demand growth slowed down in 2012, driven by the weaker global environment and lower investor and consumer confidence.

•    Price stability has become a top priority. Inflation started rising again after reaching a record historical low rate of 3.6 per cent in early 2012, but the authorities have confirmed commitments to inflation targeting and a floating rouble.

•    Russia joined the World Trade Organization (WTO) in August 2012. After 18 years of negotiations, the terms of accession were agreed at a Ministerial Conference in Geneva in December 2011 and ratified by the Russian parliament in July 2012.

The key long-term priority for Russia is diversification of the economy away from its strong dependence on oil and gas exports. This requires modernization of the economy, and serious improvements in productivity and the investment climate.

The benefits of economic growth and development need to be shared more equally across regions. In addition to fiscal transfers, this requires major improvements in the regional business environments, so as to attract more private investment.

The role of the state in the economy needs to be further reduced. Faster progress with privatization can help to increase the country's productivity and competitiveness (particularly important following WTO accession) provided that the privatization process is transparent and increases competition.

Major structural reform developments

Russia joined the WTO in August 2012. The terms of accession were agreed at a Ministerial Conference in Geneva in December 2011. The Russian parliament ratified the agreement in July 2012 thus completing a long accession process that started back in 1993. Under the terms of the accession, Russia has made a number of commitments. These include: gradually lowering a number of import duties in agriculture and manufacturing (by around 2-3 percentage points on average); relaxing restrictions on foreign entry in the services sectors such as insurance and telecommunications; limiting future agricultural subsidies; and introducing non-discriminatory tariffs for trans-shipment of goods through the country. Many provisions include transition periods of up to nine years, depending on the sector. Work on Russia’s accession to the Organisation for Economic Co-operation and Development (OECD) is ongoing.
 
In January 2012, Belarus, Kazakhstan and Russia launched the next stage of economic integration. This stage envisages the creation of a common economic space within the Eurasian Economic Community, building on the Customs Union between Belarus, Kazakhstan and Russia launched in 2010. The stated ultimate goal of the Community is free movement of goods, capital and people, as well as harmonisation of macroeconomic and structural policies. The Eurasian Economic Commission, a newly established supranational body of the community with nine members (three from each country), is expected to gradually take over some responsibilities from the national authorities in areas such as competition policy, technical regulations and environmental standards. Key decisions will be taken by the Council of country representatives based on the “one country, one vote” principle. The exact modalities and timetable for the next steps of integration are yet to be fully clarified.
 
Despite delays, some progress was made with privatisation. The revised privatisation programme announced in June 2012 is broadly in line with the previous versions. It foresees the sale or initial public offerings of shares in state-controlled companies in various sectors including transport, power generation, agribusiness, banking and insurance. Implementation of the previous privatisation programme was slower than initially envisaged but recent noteworthy sales have included a majority stake in Freight One, a former cargo subsidiary of Russian Railways, and minority stakes in United Grain Company and Sberbank. Other sales anticipated in the near future include minority stakes in Novorossiysk Commercial Seaport and Sovkomflot, a maritime company specialising in oil and gas shipping.  Further selected majority privatisations are envisaged in the coming years.
 
Two major oil companies have established a strategic alliance. The landmark deal, signed in September 2011 between Rosneft, a leading state-owned oil company, and ExxonMobil, a major international oil company, envisages the establishment of joint ventures to explore oil and gas in the Russian Arctic where Rosneft will hold two thirds of shares and ExxonMobil the rest. Rosneft in turn is expected to get stakes in at least six projects of ExxonMobil. Estimates of long term investment needs for exploration in the Arctic range within US$ 200-500 billion and the strategic alliance is expected to give a major boost to the development of new oil and gas fields.
 
The Direct Investment Fund (DIF) has started operations. The fund was set up in 2011 with the objective of promoting innovation and modernisation of the economy through leveraging private co-investment by foreign companies. It is managed by a fully owned subsidiary of VEB, the state development bank. In April 2012 DIF and China Investment Corporation (CIC) agreed to each contribute US$ 1 billion to a joint investment fund, with further contributions from Chinese institutions expected in the future. The fund’s management company will be owned 60 per cent by the Russian state (via VEB) and 40 per cent by the Chinese state (via CIC). The fund will target investments in Russia and the CIS as well as Chinese companies actively dealing with Russia.
 
The work on development of local capital markets continued. In December 2011 the parliament passed a law on Central Depository. As part of the agenda of transforming Moscow into an international financial centre, a number of measures have been adopted to liberalise the domestic sovereign rouble bond market and make it easier for non-residents to trade in Russian securities through international clearing systems such as Euroclear.
 
Amendments to the competition law have made rules of competition enforcement clearer. Under these amendments, collusion and cartel behaviour have become more explicitly defined while a number of other offenses have been decriminalised, contributing to a better, more predictable business environment.

Source of text and image: EBRD Text and information from www.ebrd.com